Sunday, August 8, 2010

Dow - Head and Shoulders Formation ?

Courtesy of chartpatterns.com

A typical Head and Shoulders reversal pattern is as shown above. Most books mentioned that it has to be confirmed by volume pattern that has the highest volume at the left shoulder, a lower volume at the head and the smallest volume at the right shoulder.

Bulkowski has ranked head and shoulders as the best performed reversal pattern in a bull market out of 21 reversal patterns. Bulkowski's research on head and shoulders is as shown below.

Courtesy of Bulkowski


There were articles by analysts in the last few weeks mentioning about the possibility of a ' Head and Shoulders' formation by Dow as shown below.


At this stage of Dow's pattern development I rate it as of low possibility that Dow will form a Head and Shoulders pattern for a major reversal. As shown by the chart below, since the March 2009's Low of 6547, Dow has completed 5 waves until April 2010 before the May and June pullback. According to Elliott wave principle any rebound wave whether it is a wave 2 rebound or a wave B rebound will never end with 5 waves.



Even if Dow were to turn down at this moment to go below June's low, it is still a wave (II) pullback, there will still a wave (III) uptrend with a minimum high equal to April's peak of 11204.

As rated by Bulkowski as the No. 1 bull market reversal pattern, the 2007 head and shoulders formation did confirm the market plunge following its formation, a pullback of 53% within 17 months.


However, there were many examples in the past where a potential head and shoulders pattern failed to complete as shown by the following charts.

Early 2000

First half of 1991

1988

1986

The fact is whenever there is a pullback to equal to or lower than its previous low after a recent high, the next upward movement has the potential of forming the right shoulder of Head and Shoulders pattern.

Since I am treating the uptrend since March 2009's low as a rebound wave as mentioned in my previous posts and since a rebound wave will have 3 waves, I prefer to look for reversal pattern at the last journey of wave 3 to determine the ending point for wave 3.

If the current uptrend since June's low were to continue, a critical point is when Dow approaches the April high of 11204 as the level of 11204 can be a potential ending point of major wave (III), the end of the bear market rebound since March 2009's low of 6547

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