Looking at chart patterns can sometimes help identify future market direction. While this obviously is not a perfect science, or a guarantee in any way that things should work out as a pattern indicates, I have seen remarkable consistency with some of them over the past 25 years.
In previous posts, I have referred to some forecasters who include chart patterns in their analysis to view the big picture. One of those patterns that the S&P; 500 is currently generating is a huge head-and-shoulders (H&S;) formation. If you’re not familiar with it, here’s what the picture looks like:
This is a weekly chart, and the head and both shoulders are clearly defined. The theory is that if prices decline from the right shoulder, and break through the neckline (indicated by the red slanting line), that would complete the pattern and lead to lower prices.
The neckline resides currently in the 1,030 area, which means a 10% drop from current prices would get us to that level. With the markets having run up since Labor Day on hopeful economic assumptions, a slide back down could happen in a hurry, should these assumptions be met with disappointment.
Conversely, if prices rally from the top of the right shoulder and end up rising above the high point the “Head” has made (April 2010), all bets are off, and the bullish trend is likely to continue.
While chart patterns such as this one are not an integral part of trend tracking, I use them occasionally to see if I can get a heads-up on future market direction.