Tuesday, July 14, 2009

No chart pattern is infallible

In the last few days I noticed that more and more people talking about 'head and shoulders' reversal. CNBC, Bloomberg, news paper, investment letters..... When my friend told me that while having lunch, he overheard a few guys at the next table talking about 'head and shoulders'. That's it, God will never let anybody sees thing so clearly. If the majority is looking for a 'head and shoulders' reversal, it may not turn out to be a 'head and shoulder'. If everybody is thinking about 'head and shoulders', then I am 100% sure it is not 'head and shoulders'. The stock market simply can not exist if everybody is thinking in the same way and doing the same thing.
A good chart technician always remember these two things:

a) No chart pattern is infallable. It works most of the time but not always.

b) He must always be on the alert for chart signs that his analysis is incorrect.

'Head and shoulders' pattern can fail. John J. Murphy mentioned in his book Technical Analysis of the Financial Markets, "Once prices have moved through the neckline and completed a head and shoulders pattern, prices should not recross the neckline again. Any decisive close back above the neckline is a serious warning that the initial breakdown was probably a bad signal, and creats what is often called, for obvious reasons, a failed head and shoulders".



Looking at the charts for Dow and S&P, a failed head and shoulders can not be ruled out at this stage.

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