The NYSE composite has spent the last year building a classic broadening top pattern. The pattern develops as strong hands distribute to weak hands, and when it occurs, often marks a transition from bull to bear.
1. Broadening formations are relatively rare and because the pattern itself is difficult to trade systematically (as the boundaries are continually moving farther apart) aren't given a lot of attention in literature.
a. Edwards and Magee in their seminal "Technical Analysis of Stock Trends" suggest that the broadening top, as a rule, only appears near the end or in the final phases of long bull markets.
b. Shabacker in his classic "Technical Analysis and Stock Market Profits" also remarks that the pattern is rare, but extremely important, often marking an important transition from bull to bear.
2. In my experience both Shabacker and Edwards and Magee are correct. They are rare and generally very hard to trade (so I don't bother) but they do offer an important warning of a potential phase transition.
3. Note that the pattern isn't always well defined, with overthrows and underthrows of the pattern boundaries occuring regularly. This is what makes it hard to trade or design a trading strategy around.
a. The pattern is extremely compelling when it appears in individual equity charts.
As I see it, these are the important chart elements.
1. The composite broke the trendline from the March 2020 low. This changed the weekly trend from up to neutral.
2. After breaking the trendline, the Comp spent most of the next year moving laterally and tracing out a clear broadening formation, warning of a potential phase transition.
3. Over the last few weeks the Comp violated the rising trend line (marked on the chart) along the last three internal trend line lows, and accelerated to the lower boundary of the pattern.
4. I have included the 10 and 40 week moving averages. The two averages are roughly equivalent to the 50 and 200 day averages. Note that the 10 has rolled over and is moving to meet the flattened out 50. Often a narrowing between two moving averages marks an important market decision point. Its interesting that it is occuring at the very moment when the broadening formation appears to be nearing a conclusion.
5. If the market does begin to breakdown there are several initial move targets that can be constructed. I like to look for confluences of move targets and chart supports. The more the merrier.
a. I like to overlay the .382, .500 and .618% retracement targets first.
b. Next I locate chart supports. In this case, the area around the 14183 high from early 2020 can be expected to generate at least some buying interest.
c. There is also a measured move target that can be generated using the width of the broadening top, it projects to roughly 14400.
d. 14089 is the .382% Fibonacci retracement.
6. The support confluence provided by the pivot, the Fibo and the measured move suggest an initial support zone between 14089 and 14400. I would clearly watch this roughly 2% wide zone for reversal behaviors to either reduce shorts or perhaps, if the right behaviors develop, consider new longs.
But again, the MAIN point is not so much generating trading targets as recognizing the pattern as potentially a harbinger of an important trend change. This is particularly important against the context presented in the macro overview posts of the last few weeks.
Good Trading:
Stewart Taylor, CMT
Chartered Market Technician
Shared content and posted charts are intended to be used for informational and educational purposes only. The CMT Association does not offer, and this information shall not be understood or construed as, financial advice or investment recommendations. The information provided is not a substitute for advice from an investment professional. The CMT Association does not accept liability for any financial loss or damage our audience may incur.
1. Broadening formations are relatively rare and because the pattern itself is difficult to trade systematically (as the boundaries are continually moving farther apart) aren't given a lot of attention in literature.
a. Edwards and Magee in their seminal "Technical Analysis of Stock Trends" suggest that the broadening top, as a rule, only appears near the end or in the final phases of long bull markets.
b. Shabacker in his classic "Technical Analysis and Stock Market Profits" also remarks that the pattern is rare, but extremely important, often marking an important transition from bull to bear.
2. In my experience both Shabacker and Edwards and Magee are correct. They are rare and generally very hard to trade (so I don't bother) but they do offer an important warning of a potential phase transition.
3. Note that the pattern isn't always well defined, with overthrows and underthrows of the pattern boundaries occuring regularly. This is what makes it hard to trade or design a trading strategy around.
a. The pattern is extremely compelling when it appears in individual equity charts.
As I see it, these are the important chart elements.
1. The composite broke the trendline from the March 2020 low. This changed the weekly trend from up to neutral.
2. After breaking the trendline, the Comp spent most of the next year moving laterally and tracing out a clear broadening formation, warning of a potential phase transition.
3. Over the last few weeks the Comp violated the rising trend line (marked on the chart) along the last three internal trend line lows, and accelerated to the lower boundary of the pattern.
4. I have included the 10 and 40 week moving averages. The two averages are roughly equivalent to the 50 and 200 day averages. Note that the 10 has rolled over and is moving to meet the flattened out 50. Often a narrowing between two moving averages marks an important market decision point. Its interesting that it is occuring at the very moment when the broadening formation appears to be nearing a conclusion.
5. If the market does begin to breakdown there are several initial move targets that can be constructed. I like to look for confluences of move targets and chart supports. The more the merrier.
a. I like to overlay the .382, .500 and .618% retracement targets first.
b. Next I locate chart supports. In this case, the area around the 14183 high from early 2020 can be expected to generate at least some buying interest.
c. There is also a measured move target that can be generated using the width of the broadening top, it projects to roughly 14400.
d. 14089 is the .382% Fibonacci retracement.
6. The support confluence provided by the pivot, the Fibo and the measured move suggest an initial support zone between 14089 and 14400. I would clearly watch this roughly 2% wide zone for reversal behaviors to either reduce shorts or perhaps, if the right behaviors develop, consider new longs.
But again, the MAIN point is not so much generating trading targets as recognizing the pattern as potentially a harbinger of an important trend change. This is particularly important against the context presented in the macro overview posts of the last few weeks.
Good Trading:
Stewart Taylor, CMT
Chartered Market Technician
Shared content and posted charts are intended to be used for informational and educational purposes only. The CMT Association does not offer, and this information shall not be understood or construed as, financial advice or investment recommendations. The information provided is not a substitute for advice from an investment professional. The CMT Association does not accept liability for any financial loss or damage our audience may incur.
CMT Association is a global non-profit credentialing body committed to advancing the discipline of Technical Analysis. Improve investment performance and career opportunities: www.cmtassociation.org
