The head and shoulders pattern is frequently how a price index puts in a top, and, while it may be a bit early to start talking about it, it is one possible scenario that we can anticipate.
A few weeks ago we identified a rising wedge pattern, which believed would resolve downward because that is what that pattern usually does. The expected breakdown happened today, and now we look for signs of what may happen next.
There is a line of support drawn from the May 2013 top that has a lot of credibility because it engages three tops and two bottoms. That line is the most obvious place for prices to find at least temporary support, even if prices are destined to move lower. We can see that a left shoulder and head have already been formed, and if prices bounce off that support line (which is also the neckline), there is a good chance that a right shoulder will be formed.
[Related: Long-Term Outlook Still Bullish; Expect Correction to End With "Intense Selling"]
For the formation to be somewhat symmetrical the bounce would have to be fairly shallow and with a duration of several weeks. If the head and shoulders breaks down after the right shoulder has formed, the minimum downside target would be about 1700. As I said, this is only one possible scenario, but things are pretty well aligned for that outcome. But first things first. Let's see if there is a bounce next week.
The above content was an excerpt from the January 24, 2014 blog for Decision Point subscribers. Click here for a free trial.
