Today's price action opened the door to a bearish scenario that began to crystallize late last week. As I mentioned in Monday's report (see Hanging by a Thread
), most of last week's price action consisted of nothing but churning and distribution. Clearly, the Big money is selling to the small guy.
Whenever price fails to bounce vigorously off the 50-day moving average (50-dma), you know that buyers are nowhere to be found. First, it was the S&P 500 ($SPX), and today's it was the Nasdaq 100 and Composite ($NDX, $COMPQ). Moreover, the Russell 2000 ($RUT) has so far managed twelve consecutive closes below its 50-dma. This all-important moving average is now down-sloping, indicating the recent birth of a downtrend. This trend reversal appears to have occurred around April 9th.
The chart of the Russell 2000 below carries some seriously bearish implications. Clearly, the overall pattern is one large Head and Shoulders (HS) that has three smaller-degree bearish patterns embedded within it. The head and right shoulder are both HS patterns of smaller degree, while the left shoulder is a triple top. Ominous.
There are some important characteristics to note about the large-degree Head-and-Shoulders pattern below. According to Bulkowski (see Bulkowski's Head and Shoulders Explained
), the more asymmetrical the HS top appears, the better it performs. In our case, the left shoulder is further away from the head, increasing the odds that the pattern will outperform. Also, an HS pattern with a lower right shoulder compared to the left shoulder usually yields a large post-breakout decline (see Bulkowski's Head and Shoulders Tops
). Clearly, this pattern has everything going for it - A coiled spring with a downside target of 720.
Chart 1. The chart of the Russell 2000 sports a Head-and-Shoulders pattern. Within it, smaller-degree bearish patterns are embedded. The right shoulder
can be considered either a bear flag or an HS.
Chart 2 below of the S&P 500 conveys a similar message. The head traced out a pattern of three consecutive peaks, while the right shoulder unfolded as an HS and a rounding Top. The right shoulder is higher that the left shoulder, but the performance impact should be minimal, according to Bulkowski. As shown on the chart, the downside target per the measured-move guidelines is approximately 1293. This is consistent with the 1293 support level highlighted on chart 4 of Monday's report (see Hanging by a Thread
Chart 2. The chart of the S&P 500 sports a Head-and-Shoulders pattern. The right shoulder can be considered
either a bear flag or an HS.
On Wednesday, the FOMC announcement will likely be business as usual. That is, no QE3. Moreover, any hint of hawkishness on the part of a couple of members will add fuel to the fire. Without QE3, the Big Money will stay on the sidelines. And without the Big Money, stocks cannot go anywhere but down.
Be prepared for a potentially bloody end of week. With all that said, this forecast doesn't come with any guarantees.
Estimated downside targets: S&P 500 > 1293, Russell 2000 > 720
Peter (Twitter: @61Point8)
P.S. I publish my thoughts, analyses, and trades primarily for my own benefit, hoping it will also benefit others who might be seeking some guidance. Retweets are always appreciated.