Which way will the market go?

Like Wall Street, our market has been ambivalent in its course of direction.

One day, it could be headed in one direction and on another day, in the opposite direction without warning or explanation.

At times, it could be moving along the course of Wall Street and in another time, it could be moving in opposite course. But just the same, it has for so long remained ambivalent in its ultimate course of direction like Wall Street.

Interestingly, our market and Wall Street had been acting this way under same market factors that existed all the time as they moved in either direction.

For instance, the threat of another major recession in the US had long been a major concern. This very concern has led to market softness so often a time. Yet, at times, this very concern is set aside as investors shrug off their fear and push the market higher as they chose to become more positive over fleeting or not-so-significant market developments.

The same is true with the tenuous fiscal and financial conditions in Europe. Their impact has been influential in affecting the attitude of investors in moving the market higher or lower.

However, after last week’s trading results, it seems that this ambivalent behavior of the market may come to an end soon. And to my mind, this should be happening in the next two weeks.

Price patterns

When stock prices are heading upwards, the market is said to be heading north. And when stock prices are falling down, the market is said to be heading south.

According to a technical review, Wall Street is moving on a “head and shoulders” pattern. And as of last Friday, it is said to be already at its right shoulder.

As generally described, the head and shoulders pattern consists of three segments. These segments, however, would have a similar and familiar pattern of price movement that peaks and subsequently declines.

The first segment is called the “left shoulder,” the initial segment that leads into the formation of the head and shoulders pattern.

The second has a similar pattern: It peaks and declines. And the peak established in this segment of the head and shoulders pattern is the highest among the three. It is called the “head.”

The third segment is called the “right shoulder” and it has a peak that is usually as high as the first.

Based on reliable reads, in order for the left shoulder to be formed, it should be propelled by a “powerful large volume up-move, followed by a small volume correction” that goes back to the level where it started.

The head or peak of the second segment is formed by a rally which overshoots the previous high or peak of the first segment.

Like in the left shoulder, the head completes its movement by a price drop down to the level of the left shoulder.

According to consensus, the volume in the second segment “is high in the rally phase, but lower overall than in the left shoulder.”

This sets another significant dynamics in the head and shoulder equation.  The rally that formed the right shoulder is weaker than the rally that formed the head. Thus, the volume of the third segment is critical. It should always be lower than the rally that made the head and it should always be lower than the volume that led to the price drop in the left shoulder.

The formation of the head and shoulders pattern is completed when the line connecting the base of the left shoulder and the head, which is called the neckline, is broken.

As the fall that followed the price peaks in the first, second and third segments, this point in the pattern would provide another “sell” opportunity.

More importantly, the price swing or drop created from the neckline is expected to be as long as the total length or height of the peak of the head.

The price movement described above is called “head and shoulders top.”  The reverse of this pattern is called the “head and shoulders bottom.”

While the former is a “sell” signal indicator, the head and shoulders bottom is deemed as a buy signal tool.

Here, the volume behaves somewhat differently, according to references.  “When the price drops in the head, it is much less pronounced than the right shoulder, (and) the breakout from the neckline, on the other hand, is accompanied by a much greater volume than in the top.”  The price objective of the breakout, nonetheless, is expected to be equivalent to the neckline base to the peak of the head.

Even with my long years in looking at price patterns, the described formations are not always easy to recognize. Under actual market conditions, the neckline could appear rising or falling. The head could also appear small or double, yet prove to be valid.

Bottom-line spin

Our market appears to be moving into what could be described as a “box” formation.

In a box formation, prices move or fluctuate between the support and resistance lines in an extended space of time that could involve days, weeks or months.

According to most references, the box formation is indicative of the market’s balanced equilibrium between supply and demand. It offers excellent trading opportunities. But only a breakout—either upwards or downwards—out of the box would lead to a significant trading opportunity as in the head and shoulders pattern.

This kind of event may soon be happening. In the meantime, the behavior of the market may linger on to complete the last phase of its current price movement. Thus, this may lead our market to further head lower like Wall Street is expected to be in the next two weeks.

In this connection, may I remind you of the adopted trading theme and philosophy of this column, for the foregoing prognosis and its elicited action may always change.

Remember that “making money in stock trading does not mean knowing the secrets of forecasting future prices.”

(The author is a licensed stockbroker of Eagle Equities Inc. Market Rider can be reached through [email protected] or at www.kapitaltek.com.)