Friday, February 5, 2010

Mother of ALL Head and Shoulders

Predicting that the market could fall to 7,000 a few years ago was not that much of a challenge. Anytime you get a well-formed shoulder, as happened from 1998 to 2003, and the market then takes out the high level for that period (12,000), one has got to start thinking of the head and shoulders formation. While it is often difficult to time the market top, one can remain confident in the notion that the market will eventually fall.

And fall it did. My biggest surprise was when prices continued to run through this neckline. Now, the runup we have witnessed seems incredible for many but if we view things in the context of the head and shoulders formation, it shouldn't have been improbable that the market could climb as high as 12,000. Even now, with the Dow average breaking below 10,000, if we view the trading action that occurred between 1999 and 2000, we can see that there was a relatively long-term trade range between the 10,000 level and above 11,000 almost touching 12,000.

Normally we see the right shoulder reflects the activity of the left shoulder. This means that this market formation is usually very symmetrical. Chances are we are going to see another market meltdown with the Dow average dropping down to 7,000 or lower. But an important thing to remember is that it could take three or four years for this to occur!. In the meantime, there will be great profit opportunities. But as markets again test high levels, you might want to establish short positions in equities, and perhaps selling long term puts or buying long term calls, at the bottoms. But only be selling puts against stocks that you are short.

Normally, we project the downside target of a head and shoulders formation by measuring the neckline to the peak of the head. Since this is a symmetrical formation, we can expect the price to fall by a similar amount. Notice though that the neckline to peak is 7,000 points (from 7,000 to 14,000). A 7,000 point retracement would bring the Dow to 0! Ouch. A look at a log chart though shows a price target down below the 4,000 level.

It's always good to have a long term philosophy in the overall market when positioning your trades. We will be looking or a bottom in this market move and provide some buying ideas both for individual stocks as well as for diversified portfolios. If you have a special interest in following our ideas, be sure to contact me at to be sure that you receive all updates and ideas.

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