A potentially ominous chart pattern is forming on the S&P 500 Index currently, called a head and shoulders pattern. As the name suggests, it looks like a head with two shoulders. There is one major peak, surrounded by two smaller peaks, and these patterns are used by technicians to find major changes in trend. The current pattern could suggest coming weakness should the neckline (near yesterday’s lows) be violated. It is worth noting these patterns can happen near bottoms as well, which is known as an inverse head and shoulders pattern.
This chart has traders and social media buzzing, so we asked our own Dave Tonaszuck, CMT, for his thoughts on it.
The daily price on the S&P 500 Index is currently testing the neckline of a bearish head and shoulders pattern, which has been in effect since mid-March. If the price breaks the neckline to the downside, then a bearish price objective is set near the 2000 level support. In the event the index rallies higher from where we are now (at 2070), then the next bullish catalyst is a price close back above the 2085 swing-high level, which will establish an upward price objective between 2110–2134. In this scenario, the bearish head and shoulders pattern will become null and void.
One key point to reiterate is this doesn’t officially turn bearish until the neckline is violated, which hasn’t happened yet. Also, overall market sentiment continues to be rather dour—a plus from a contrarian point of view. In fact, looking at the American Association of Individual Investors (AAII) sentiment poll, the survey has seen more bears than bulls for three consecutive weeks. The last time that happened within 4% of a new all-time high was in April 2013, which was in the midst of a very strong bull move. In other words, this much concern near new highs could turn out to be a good thing. In the end, watch the neckline of this pattern for clues as on the direction of the next major move.
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