Alternation and the Symmetrical Triangle Pattern

Happy Father's Day!

This morning, I want to talk about alternation and the symmetrical triangle.
A few days ago, I raised the probability that whatever happened after the bounce up from the 200-day moving average @ 1257 on the S&P 500 Index would be a reaction against the down trend. So, we would know that we were in a corrective phase. We should also anticipate a long and complex correction since the previous correction (May 25 to May 31) against the down trend was a simple and sharp correction.

We should also be alert to a developing symmetrical triangle pattern. Symmetrical triangles reflect converging resistance and support levels. Jesse Livermore might say that one can see the pitched battle between Bulls and Bears as the resistance level drops lower and lower while the support level rises higher and higher. Another way to think of a symmetrical triangle is as a coil that is getting tighter and tighter before it explodes out one way with definitive force.

Personally, I do not like symmetrical triangles. They are prone to false breakouts. Thomas Bulkowski has performed important research in this regard. Bulkowski has observed that symmetrical triangles are prone to busted chart patterns and shakeouts. Life is difficult enough without sideways patterns gone awry.

In any event, here is the case for a nascent symmetrical triangle. Thursday's low of 1258 was followed by a higher low of 1267 on Friday. We have two higher lows, one after the other. This action demonstrates that the support level is rising. Check. Q: Do we have falling resistance levels? Yes, we do. The high on June 7 was 1296. The high on June 9 was 1294. The high on June 14 was 1292. The high on June 15 was 1287. The high on June 17 was 1279. Notice how the daily highs are falling down in a staircase like fashion. Each daily high is a resistance level indicating that selling pressure is greater than buying pressure. The resistance levels are forming lower highs.

At some point in time, the rising support levels and the falling resistance levels would converge forming a symmetrical triangle shape.

Q: Is this pattern Bullish or Bearish? One looks to the incoming trend to assess the probable outcome. Since we are in a down trend since May 1, 2011, I would favor further down side. Once the closing price breaks below the most recent support level of 1267, prices should drop down with force.

From the vantage point of intuition, this outcome makes sense for several reasons. First, many institutions have staked their bullish presumptions on the rising 200-day moving average (1257) providing long-term support. When 1257 is breached, their bullish presumptions will be undercut. Second, 1257 is an important level from a psychological level. It represents the Bear Stearns low from the crisis in March of 2008. 1257 represents resistance turned support on a five-year chart of the S&P 500 Index. I cannot overstate the importance of this level failing. Bulkowski has written about busted chart patterns. They are Bull Traps in that bullish money committed to a rising market has been proven wrong. A drop below 1257 would mean that former support (March 2008) turned into resistance turned into support (roughly the March 16, 2011 low) is now resistance again. Recognizing that bullish investors were wrong on the market direction and that they are now trapped in losing positions, one would expect sell orders to kick in from investors and traders trapped above 1257. Please note that, according to Bulkowski, busted chart patterns result in market moves quite a ways in the unanticipated direction. In our case and from the bullish perspective, this direction would be down.

(Remember that the 200-day moving average signals the line between a Bull Market and a Bear Market. See Sy Harding's Riding the Bear.)

Second, money managers are paid based on their end of year performance. The year began @ 1257. A drop below 1257 means the S&P 500 Index is down for the year. A negative year would not be good for the bottom line of hedge fund managers.

Third, there is no panic in the market yet. I have not seen newspaper headines screaming fear. So, this suggests that the retail investor remains too complacent for a bottom to be put in place.

Fourth, the weekly chart says the down trend remains strong. The MACD lines are open and still pointing down. The MACD Histogram is still falling. And the stochastics should fall some more.

Finally, the Federal Reserve's policy of quantitative easing (QE2) ends on June 30. Consider that the market has been propped up to a large extent since August 2010 based on the Fed's $600 billion buying of bonds. I won't go into details but the correlation between Fed buying and the rise in the market is strong. Q: What happens when the Fed stops buying? Well, we had a Flash Crash in May 2010. This time again, I don't anticipate a Flash Crash. The market doesn't repeat itself. But the line of least resistance is down. The trend is down. I would think the market reaction to the end of QE2 will be down.

Conclusion.

The more I thought about the symmetrical triangle, the more it makes sense since a symmetrical triangle is considered a long and complex correction. However, the duration of the correction may not be two weeks. In fact, I am leaning more towards a correction of four days in length.

Whether the correction be four days or two weeks, there is one certainty for now--the trend is down!

Warm regards to all of the fathers out there,

Wink

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