Stock Trading: Triangle Patterns Abound, Some Cautionary Signs

Index and individual stock charts are showing us an abundance of wedge-shaped patterns in an indecisive and volatile market. It appears likely that these patterns will resolve in one direction or the other within the next few days, and probably sooner rather than later. A lot of people are watching these wedges, so beware of a false move. At the same time, should we see a break accompanied by volume, I would trade the move aggressively. As of now, I am lightly invested, but leaning bearish. It is important to note that volume has been feeble on the most recent rally, and it is drying up as the days progress.

I have been focused on shorter time frames when looking at charts:

- QQQQ (QQQQ) looks the most bearish out of the index ETF’s I follow. Apple’s (AAPL) earnings last night may change the technical picture, so Wednesday morning’s trading will be worth watching closely. At any rate, QQQQ appears to be already breaking down out of the triangle pattern. Perhaps Apple results will rescue the pattern, but I am inclined to short strength here.

- Russell 2000 Index ETF (IWM): The small caps are still in limbo, and are trading in a tight range. A convincing move above 55.00 will be a buy signal, while a drop below 52.50 would have me selling short.

- SPY (SPY) is loser chart. I am looking for a convincing break above 99.20 to start long positions. Going into Wednesday, I am focused on finding safe short picks, and would be adding aggressively short on a break below 91.50.

- MidCap SPDRs ETF (MDY): The midcaps are also showing investor indecision. Given the descending moving averages and lackluster upside volume, I think this is more likely to resolve as a continuation lower rather than a sustained move higher.

In addition to the low volume in this move off of the lows, other signs indicate we have not reached bottom yet. Mark Hulbert has a good article up on MarketWatch, Anatomy of a Bottom. Key quote:

Capitulation has a number of distinguishing psychological characteristics, such as investor disgust and exhaustion. Having been burned by the market for so long, investors capitulate by resolving never, ever, to trust the market again.

In the wake of capitulation, therefore, interest in the market declines. Apathy rules.

To be sure, this definition cannot be mechanically measured. It is hard to pinpoint when investors become maximally dejected and apathetic. But my hunch is that we have yet to experience capitulation.

Also consider this Sentiment Overview: Week Of October 17th, 2008.

The AAII sentiment survey is whistling a different tune however. The bears fell dramatically from 61% to 40% and the bulls rose to 41%. That’s a dramatic shift. Not only for the decrease in bears but because technically we now have slightly more optimists than pessimists. For confirmation of a market bottom and a healthy rally, I’d prefer to see continued doom and gloom.

There was a similar uplift in mood for the Consensus sentiment survey. Bullish sentiment rose from last week’s 21% to 36%. Again, not the sort of thing that gives contrarians confidence for a sustainable rally.

I have been hearing a surprising number of people who think this is a great value opportunity. As much as I admire Warren Buffett, I think investors will be able to acquire equities at yet lower prices. Recent buyers, and those who have moved bullish in the past week, were burned badly during the prior big drop, since most everybody was. They are going to be risk averse going forward, and as a result likely to be weak holders. If the market starts to sell off again, the newly bullish sentiment could turn quickly.

As we continue into earnings season, we will be able to consider results and forward guidance, and make our decisions on a firmer basis. At the same time, I suspect next quarter’s earnings reports will provide a clearer indication of the consequences of the credit collapse. That being the case, take this season’s forward estimates with a grain of salt.

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Comment by alan

2008-10-22 07:47:34

Hi Scott,

Many thanks for sharing your analysis.

I was just wondering how did you derive your technical trigger on SPY of $91.50?

Thank you very much!

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Comment by Scott

2008-10-22 13:26:55

Hi Alan
Thanks for the question.
91.50 corresponds to the lower trendline I drew.

At the same time, I was also paying a lot of attention to the other index ETF’s, since QQQQ and IWM had somewhat cleaner patterns.

Scott

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Comment by Scott

2008-10-22 13:16:25

Hi Alan
The 91.50 level corresponds to the lower trendline I drew on the chart. I am paying a lot of attention to all of the index charts though, and some are a bit easier to interpret than SPY.

Anyway, I think now we’re headed lower, since we’ve broken down out of the triangle patterns I was mentioning.

Scott

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