A Head-and-Shoulders Fail Still Is Warning ~ The Risk Averse Alert

Friday, August 31, 2012

A Head-and-Shoulders Fail Still Is Warning

There is a very good chance the market is on the verge of a significant setback, and in the case of the NYSE Composite index, likely to challenge, if not nominally take out, its 2011 low...


More or less the same ominous technical setup as was seen at last year's top and initial turnover is presented via the NYSE Bullish Percent Index. Having registered a negative divergence at this year's mid-March NYSE Composite peak, significantly deteriorating participation in the market's recovery following its May setback is evidence now in place, putting the market in position to crater sometime upcoming.

Before we get excited, though, we should wait for this measure's relative strength (top panel) and momentum (bottom) to turn over and likewise point the way down. As it stands right now, wave c of an a-b-c, Elliott "zig-zag" up from early June might still be forming, with its 5th and final wave possibly to unfold over days ahead. (On a related side note the two circled Bullish Percent Index peaks, last year and presently, venture to display a negative divergence finding this year's higher Bullish Percent Index reading at a lower NYSE Composite print further foreshadowing trouble ahead.)

One telling thing to watch once this garbage turns over is that large head-and-shoulders top in the NYSE Composite Index detailed here on July 9th. Taking into account the complex Elliott corrective wave thought developing since March '09 bottom and the likelihood its completion remains some months off, there is a heightened possibility the NYSE's head-and-shoulders top will be one of those instances described by Edwards and Magee in "Technical Analysis of Stock Trends" where the distribution this technical pattern indicates does not immediately translate into a neckline break and subsequent selloff reaching the minimal objective a head-and-shoulders pattern otherwise reliably predicts (this targeting below the neckline the distance between the head's peak and the neckline). According to the book's authors this sort of occurrence is not unusual, leading to the following conclusion:
"A Head-and Shoulders that does not 'work' is a warning that, even though there is still some life in the situation, a genuine turn is near. The next time something in the nature of a Reversal Pattern begins to appear on the charts, it is apt to be final."

So, then, regarding present uncertainty as to how far along in its development is the Elliott "flat" thought forming since October 2011 the second "three" of an a-b-c-x-a-b-c complex corrective wave up from March '09 bottom, we might better assume the flat's wave b forming since mid-March and, itself, taking the form of an Elliott "flat" (i.e. 3-3-5), presently is unfolding and looking to complete with the market's anticipated, upcoming decline likely challenging last year's lows. Following, then, would be wave c of the second "three" unfolding in a 5-wave move higher and completing the "flat" forming since October 2011. Whether this final advance carries the NYSE Composite Index to a new high, post-March '09 bottom remains to be seen.

As this broad market measure since 2011 top has been persistently weakening, the NYSE Composite Index might be in store for but further divergent performance relative to the NASDAQ Composite, much as was seen over a far shorter duration in the August 2008 period presaging the market's subsequent gassing. But only extending such divergent performance already in evidence since last year's peak (let alone since March '09 bottom), completion of the [smaller] "flat" forming wave b might arrive sooner than yesterday's view implies and hasten the long-anticipated bloodbath likely to follow once wave c of a larger "flat" forming since October 2011 completes, which outcome continues to be objectively substantiated by the market's persistently weakening, underlying technical state.

Fast Money
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