When it’s this Obvious

Classic charting 101 shows an almost ideal (too perfect?) head and shoulders reversal pattern that has developed on Goldman Sachs, GS. When patterns are this obvious, watched by so many traders/ investors, I have found they usually don’t work. Usually ….

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It’s important to note the pattern has not yet triggered so until it does, it is nothing more than a picture of beauty and something that “could be”. If, on the other hand, it does trigger and play out

1)     The pattern’s target is down at “T1”.

2)     The target decline is ~32%.

3)     It would likely occur very quickly as there is little support until you reach the $165 level.

4)     The financial sector would be in a world of hurt as it would likely mirror GS’ decline.

5)     The US stock market would likely have a much, much further fall in store as its, arguably most important sector, would be falling precipitously.

6)     It couldn’t happen to a nicer company (the “evil squid”)

Under the Dome

October turned out to be a brutal month for stocks causing a lot of technical damage as you can see when you look under the hood of the indexes at individual stocks. So many have begun to rollover after forming longer term topping patterns, a precursor and setup for potential bigger declines. A good example can be seen in the chart of Charles Schwab, SCHW.

As you can see over the last year, the price of SCWH has transitioned from being in an uptrend (higher highs and higher lows) to now being in a downtrend (lower highs and lower lows). Notice how the $49 area has acted as support during the entire transition. October’s selloff finally pushed the stock below support which opened the door for a quick flush and an almost 19% decline in 10 short trading sessions.

What Was Support is Now Resistance

As with most selloffs, this one too ran out of steam on capitulatory volume and on an oversold RSI momentum as the dip buyers and opportunistic traders stepped in to reverse prices higher. Higher they went to take back the majority of October’s decline. Notice where the recent rally stalled? Right where is should … the $49 area.  When support ($49) is broken from the top it becomes resistance ($49) from the bottom.

This is a great opportunity for short sellers to take a position, just under resistance. If SCHW rolls over to retest October’s lows, or even extend beyond there is at least a 15% return opportunity. To manage risk, if you are short there is no reason to hold the position if price moves back above resistance which would subject you to a small 3-4% loss. This works out to be a more than 3:1 reward to risk ratio, right in the sweet spot for risk capital opportunities.

On Average – For What it’s Worth

When it comes to the markets, I detest the words “on average”. There is nothing average about a random system. But yet, as humans, we prefer structure and struggle with the chaos that non-linearity brings which is why we futilely attempt to organize it through averages.

In attempt to put the recent market correction into context, the author of the chart below has selected a small sample of data to determine the length of time it takes until investors find out whether a pullback becomes an opportunity (buy) or (sell) bear market. If the market weren’t random, this sort of data would be very helpful and of great value to every investor. Who wouldn’t want to know that all you have to do is wait 13 weeks, see which way the market is going and go all in (either short or long). Sadly, it’s never as easy as that otherwise we would all be gazillionaires. 

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I give the author an “A” for effort but there is nothing actionable here nor does it provide an “edge” to make money. While the chart contains 47-years’ worth of data, depending upon their definition of a “bear market”, it may only consist of 4-6 data points which is too few to draw any sort of statistical inference and significance from. The bottom line is that because of the non-linear and random nature of the markets there is nothing average about “average”.