Trader’s Narrative

It is difficult enough to identify a technical pattern once it has completed; correctly identifying one in mid-stride and anticipating its completion takes a lot of gumption and luck. In a recent attempt to analyse the market action, I described it as a flag formation within a larger, ascending wedge pattern.

Now, taking into consideration the range bound trading, it looks to me that the S&P 500 index might be forming a rounding top. Take a look at this annotated chart to see what I mean:

The blue guidelines drawn on the chart follow the main path of prices as they thrust out of the March low. During the very first few months, the gains were incredibly intense. But as time went on, momentum fell back to a more sustainable slope. Until finally, prices have been basically comatose for the past few weeks.

What we are seeing reflected in the chart is the clash between sellers and buyers. At first, buyers were incredibly aggressive but they’ve now mostly given up to the sellers. The process was a gradual one as demand waned in the face of increasingly intense supply. Rounding tops (or turns) are challenging because unlike the majority of other patterns, the resistance and support lines are in continuous movement.

According to the classic, Technical Analysis of Stock Trends by Edwards and Magee (bold is my emphasis):

In the Head-and-Shoulders type of Reversal, the trend surges, struggles, attacks again and again before it finally gives up and retreats. During this struggle, the balance between the forces of supply and demand fluctuates, often wildly, until finally the one overcomes the other. In Multiple Formations, a similar process goes on but rather less violently and, over a period of time, the progressive changes from one force to the other becomes clearly apparent. The Rounding Turn is a much more simple and logical manifestation of this technical phenomenon. It pictures simply and plainly a gradual, progressive and fairly symmetrical change in the trend direction, produced by a gradual shift in the balance of power between buying and selling.

If I’m correct, then the selling pressure will continue to gradually increase until it is equal to and then stronger than the buying demand. While this technical pattern is rather rare, much of the other technical data we’ve looked at recently corroborates a slow, gradual loss of leadership and momentum:

• NYSE Cumulative Advance Decline Line (operating company only)
• Losing The Generals: Market Leadership Deteriorates
• New Highs For The Year But Market Breadth Stinks