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S&P 500/Dow: Topping Formation in Question Working its Way Towards Reality

S&P 500/Dow: Topping Formation in Question Working its Way Towards Reality

Paul Robinson, Strategist

What’s inside:

  • The S&P 500 swiftly rejects resistance; market wipes out Tuesday’s gains
  • Topping formation (head-and-shoulders) potential increasing, but not there yet
  • Pattern development comes at interesting juncture in time and price

As it turned out, the resistance zone we had penciled in around 2078/83 was all the market could handle following the 3-day bounce. The S&P 500 revisited resistance yesterday morning for about 5 minutes before wiping out most of Tuesday’s rally, while the Dow wiped out all of it.

Yesterday, I said regarding the short-term hourly chart, “if buyers can’t chomp through resistance and a rejection results in a drop below support, then the inverse H&S formation will come under fire and alternative paths will need to be considered.”

Lately, the focus in most pieces has been primarily on short-term levels and chart configurations as the market continues to search for broader direction in a mostly directionless market over the past few weeks. So, stepping back to the daily timeframe: one of the scenarios touched on briefly yesterday was the possibility of seeing the S&P 500 (and Dow) carve out topping head-and-shoulders patterns. It’s still a little premature and the patterns may never trigger. (Keep in mind: lots of charts start out looking one way, but never follow through. For H&S patterns this means a break of the neckline before we have confirmation.)

A couple of simple reasons to believe the H&S formations will come to fruition are – timing and positioning. In terms of time, we are in a historically weak performing month for stocks. In terms of positioning, this development is taking place below pretty significant overhead levels for both the S&P and the Dow; 2083/116 zone and 18150/365, respectively. To further add on a different note, the Nasdaq lagging as far behind as it is, is not a sign of broad market health.

It’s fairly straightforward. The market needs to roll over and break the neckline which is easily identifiable at this juncture, and will act as support until it does. Thus far the pattern hasn’t become complex; multiple heads and shoulders, sloppy neck-line, etc. The pattern could use a little more time to develop a more symmetrical right shoulder, but sometimes the ugly ones work best, so we won’t overanalyze.

What happens if the market breaks down to neckline support and holds? Then a triangle could develop. Any experienced ‘pattern trader’ will tell you this is a fairly common occurrence. But, again, it is fairly straightforward; if the S&P and Dow don’t close below the neckline, then no official trigger.

S&P 500/Dow Daily

S&P 500/Dow: Topping Formation in Question Working its Way Towards Reality

For now, we will keep the short-term in mind and go about playing support and resistance with 1 to 3-day holds in mind, but if the head-and-shoulders pattern develops further and ultimately breaks the neckline, we will be ready to take a crack at catching a broad move lower. How much lower? We will come back and delve into further detail as this development becomes more relevant.

Looking for real-time sentiment data? Check out FXCM’s SSI Indicator.

---Written by Paul Robinson, Market Analyst

You can follow Paul on Twitter @PaulRobinsonFX, or email him directly at instructor@dailyfx.com with any questions, comments, or concerns.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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