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Strong Technical Week in S&P 500

Technical analysis of the market is really just a way to understand the sentiment that is moving the markets by applying historic relationships to future actions. There are no guarantees that history will repeat itself, but it happens often enough that certain patterns are recognizable and assist with investment management decisions. I thought you might find it interesting to see one of those patterns and how it can be used in the investment management process.

If you look at the chart above, you will see that I've drawn two blue lines that form a symmetrical triangle. This is an identifiable chart pattern that usually presages a strong move in the chart. The most common move is a resumption of the previous trend (in the case of the S&P 500, that would be down), however it doesn't have to.

A reversal of the previous trend, whether permanent or intermediate, can occur if there is enough positive momentum to push the graph above the blue line. If that happens, you can generally anticipate that there will be a significant move higher in the market.

For us to know if we are headed significantly higher, there are a few things that we would want to see:

1. the market will close above the upper blue trend line,

2. it will remain above the upper blue trend line for three consecutive days or maintain a 3% move above the line,

3. an increase in volume can be seen accompanying the reversal.

In order to get a price target for the move, you take the difference between the high and the low on the chart at the wide end of the triangle, and add that difference to the point of the breakout. In the case of the S&P 500, that is roughly 1000 – 750 = 250 point upward move IF we get and sustain the breakout. So, if we get a breakout around 900 on the S&P, we should have a target somewhere around 1,150 which coincidentally is just about the 200-day moving average.

If the pattern does in fact show a reversal, this is a great time to take cash off the sidelines and add to some of our favored areas as described in the previous blog entry on our 2009 Investment Strategy.

There seems to be a big shift in market sentiment at the moment. I do not know if it can be sustained, but if it is sustained then the reversal pattern may just come into play and provide an opportunity to recoup some of the impact of the stock market crash.