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S&P 500: Forming A Head & Shoulder Pattern? at Trader’s Narrative





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Head and shoulder formations are one of the most fundamental technical patterns. They are arguably one of the easiest to recognize on a chart and are almost always found at turning points in price. Right now we are seeing the S&P 500 Index (SPX) carving out what looks to be the right side of a head and shoulder formation:

spx head shoulder formation possible

The defining element of this patterns is not only the striking silhouette it leaves behind on price charts but also the volume that accompanies it. For downtrending reversals, like this one, we want to see heavy volume come in as the right shoulder is created. Ideally, a burst of activity both in price expansion and volume cements the pattern as it decisively breaks through the neckline.

Volume
It remains to be seen how this will play out. But if prices do continue to firm up, we may see this classic pattern play out. If it does, watch for the corresponding volume. You have to be careful to not read too much into the sudden volume collapse at the turn of the year since that is normal.

Neckline
The slope of the neckline is clearly downward, which is normal for an inverse
head and shoulder pattern. Anything from horizontal to downward is fine for such a neckline. An upward sloping one however, would be a bad sign.

Reversal or Continuation
Although most people categorize head and shoulder formations as reversal patterns, it is possible for them to be continuation patterns as well. There is a key difference.

The current pattern developing in the S&P 500 chart above, however it resolves, can not be a head and shoulder continuation pattern because in a downtrend, this would have to take the shape of a head and shoulder top (not bottom).

In other words it would have to look like an M not a W in shape. The other difference is in the required volume pattern. Instead of it showing more volume on the left shoulder and head and less on the right shoulder, a continuation H&S pattern will show diminished volume on the three points.

Meltingpot
The prevailing sentiment is too optimistic right now, which from a contrarian point of view makes it less likely to make this a lasting bottom. But sentiment is just one aspect of the market. There is also technical and fundamental. And some would say fund flows.

So this potential head and shoulder formation is just one more aspect of this crazy market that we have to consider and throw into the pot.

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11 Responses to “S&P 500: Forming A Head & Shoulder Pattern?”  

  1. 1 JokerStocks

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    Nice, the Joker thinks there will be A HUGE volume spike leading up to the that downtrend break.. Watch IVOL, stock & volume spikes people!!!

  2. 2 kissandfly

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    Head and shoulder in a bearish market does not mean down ?

  3. 3 Be

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    That looks more like a prick and balls pattern to me.

  4. 4 BourningMarkets

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    You’re right, that’s an inverted H&S pattern with coherent volume.

    I do hope that, somehow, it confirms and achieve it’s measure objective (vertical measurement from neckline to bottom) at about 1,200. It could do that without reversing the major bearish trend. I do not expect to reverse major trend right now. I think that would be unrealistic. But even if I’m right on major trend, the H&S fulfilling would be a very welcomed relief in the violence of this epic global bearish market and economy.

    Now, being prudent, consider the opposite possibility. The optimism that you point out suggests the possibility of a pattern failure. Whenever a pattern confirms breaking a neckline but fails when pulling back to it and crosses back again, the prior trend resumes, generally with a veangance. If it breaks upside, first reaction could be very bullish. But the real test would be the the pullback. If this is the development, I would bear in mind a John Mauldin saying: “bearish markets are driven by a series of disappointments”. And only end when almost nobody believes in a reversal anymore, and any bullish development is generally disregarded in disgust.

    You can check de SX7P, european banks index. I can see up to 4-5 reversal patterns’ failures, in general H&S. But I am open to both possibilities. And the first would be a relief for everybody.

    So watch out and good luck from Madrid.

  5. 5 pamtonia

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    I had a similar analysis on 1/23/2009, based not on volume, but on Options market and the New Low statistic.

    Please refer to http://pamtonia.googlepages.com/notes_1

  6. 6 john b

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    Try a symmetrical triangle instead of reverse head and shoulders. This is a much better fit and allows for a breakdown as well as a ‘breakup. and right now requires only light volume to keep evolving.

  7. 7 RDuke

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    Great chart, but I agree with john b: http://thetraderblog.com/?p=1916 looks like a great symmetrical triangle forming, I am biased for a downside break.

  8. 8 john b

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    The symmetrical triangle shows up much better on a WEEKLY CHART.

    As we all know there are 3 outcomes from a genuine symmetrical triangle

    1 Prices dribble to the end of the pattern which then has no interpretative value.

    2 Prices breakout to the upside on VERY HEAVY VOLUME which is bullish.

    3 Breakout to the downside on ANY level of volume which is bearish.

    We all wait with interest

  9. 9 Guru

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    I’m voting for the symmetrical triangle interpretation. Based on other metrics like the number of stocks crossing above longer-term the 60-day and 90-day moving averages (see my analysis at www.stockchartist.blogspot.com), I’d say the breakout will be to the upside. But it will soon run into resistance at around 975 where it will retreat and test the upper boundary of that triangle for its support …. and that’s when the real test of this bottom building will take place.

  10. 10 john b

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    I’m going with the symmetrical trangle

  11. 11 RDuke

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    Looks like we are ready to go … to the downside http://thetraderblog.com/?p=1936

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