(This is an excerpt from Friday's blog for Decision Point subscribers.)
I have been getting numerous questions regarding the possible formation of a head and shoulders formation on the S&P 500 Index chart. It is visible on the daily chart, but I think the formation is clearer on the weekly chart, and I have annotated where the components of the formation are located.
So, yes, there is a possible head and shoulders forming, but I think it is a little early to get into serious discussions about it. I only do so because it seems to be generating a lot of curiosity. We need to see a rally to about 1150, then a decline that heads back down toward the neckline. At that point we can start speculating about minimum downside projections, etc.
I should say that, whereas wedges (ascending and descending) are some of my favorite technical formations because they are so reliable in the way they resolve, the head and shoulders is probably my least favorite because they suck up a lot of oxygen as people discuss them developing, yet it is my observation that they have a low rate of fulfilling expectations.
At the present, I am more entranced in whether or not prices are going to hold above the support of the potential neckline.
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REVERSE SPLITS: On June 2 E*Trade underwent a 10:1 reverse split. What happens is that the stockholders end up with one-tenth as many shares that are worth 10 times their value before the split. One of the reasons for a reverse split is to get the price of the stock back into a range where institutions can buy it. This will supposedly help support the price and maybe move it higher, but over the years I have observed that the actual result will often be to facilitate prices moving lower. For example, E*Trade was about $1.50 before the reverse split. At that price it benefits from the "ground effect" of being so close to zero. After the split the price was about $15.00 — a good price to distribute shares, but a price that has literally no support below it. The bottom line is that reverse splits are negative events that highlight poor past performance, and warn of the likelihood of lower prices to come.
Below is the weekly chart of E*Trade. Doesn't look like a $15 stock to me.
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Technical analysis is a windsock, not a crystal ball.
