Thursday, December 22, 2011

Orderly Chaos: The S&P 500 Chart

The chart of S&P 500, as tracked by the exchange-traded fund SPY, has begun to resolve itself from ambiguity to orderly chaos.

The sharp upward reversal of Dec. 20 broke SPY's daily-chart downtrending channel, and the subsequent day plus change of trading has clarified where chart trends now stand.

As with all charts, this one can be analyzed in several ways.

In my opinion, SPY is best analyzed as an upward day-chart trend that began Oct. 4 intersecting a downward weekly-chart trend that began in early July.

Put those two together and what you get is a symmetrical triangle pattern, a series of lower highs and higher lows beginning with the Oct. 4 bottom. (The link is to, which has a wonderful series on chart patterns.)

Draw the lower trend line from Oct. 4 through Nov. 25 and Dec. 19, and the upper trend line from Oct. 27 through Dec. 6, and that's the triangle.

A symmetrical triangle is considered to be a continuation pattern, a pause before the price continues doing what it was doing before the triangle began.

In the case of SPY, the price was declining so this triangle would be interpreted as a bearish sign.

A rise above $126.25 or so would break the upper trendline, and above $127.26 would decisively break the triangle pattern.

A decline below around $120.75 would be a break through the lower trendline, signalling the conclusion of the triangle with a price move in the expected direction.

The hourly chart shows prices tracing an upward leg within the triangle which, by the book, ought to reverse before piercing the upper trendline. The hourly upchannel begins with the low on Dec. 19.

So the chart is orderly again, in that it can be analyzed. But I consider symmetrical triangles to be chaotic in terms of trend analysis. They're composed of two simultaneous opposite trends, and if that's not chaos, then the word has no meaning.

In terms of practical trading, this moves my market opinion from unknown to mid-term neutral with a bear bias, combined with near-term bullish on the hour chart.

The most recent completed leg of this triangle lasted a few days short of a month, but as the legs get shorter near the apex of the triangle,  the pace ought to pick up. So I suspect the pattern will resolve into an actual trend during the next two or three weeks.

Triangle lore says that when the trend resumes, it will move, from the apex breakout, a distance equal to the width of the base.

The base runs from $107.43 to $129.42, so its width is $22 (rounding off the penny). The apex arguably will be around $123.45 which is the midpoint between the current sides of the triangle.

That gives a downside target of $101.45.

I call it "triangle lore" because it seems like a bit of magical thinking to me. So I'll be watching it with great interest, and I'll hold on to some money-losing SPY puts that I have in my grab-bag. But I don't plan to bet the farm on a 20% price drop coming soon.

It's a possibility, one well worth watching and preparing for. But no triangle is a sure thing, except in retrospect. When the breakout comes, if it comes, then I'll trade it based on the signals of the day, as I always do, rather than trying to anticipate an unknowable future.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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