Wednesday, September 19, 2007

S&P 500 Inverted Head and Shoulders and Low Volume

The above chart has a ton of information in it. Let's just start out with the inverted head and shoulders (HandS) pattern that is outlined. Notice how the left and right shoulders held at the important TDST support lines shown. (Both of these lines were formed when the market tanked back in February, one on the way down and one on the way up.) The idea with HandS patterns is that people buy when the price holds support. The head then pierces the support lines and washes out a ton of weak hands. After a quick move back up, the market moves down again, shaking out some more people while picking up more strong hands before the big move up.

I have always had a problem with identifying HandS patterns. They always seemed very arbitrary to me. But since I've been drawing the TDST lines on all of my charts I keep coming across HandS patterns like the one shown above. Usually it is the normal HandS, where there is a bounce off of previous resistance, followed by a piercing of that resistance and then a failure. Finally there is one last test of the top most TDST line and then it is goodbye. I'm going to post everyone I see from now one.

I also have a possible explanation of the strange lack of volume in the recent weeks. This volume has confounded many of the price/volume disciples and have really killed the bears (of which I am not anymore). This downturn started when many of the high dollar quant funds began losing money. For some reason, the methods they have used for years suddenly began to fail them. This was quickly followed by a massive run on those quant funds and the failure of many. Without cash and the repricing of risk, the massive amounts of leverage that are required for the funds to work were no longer available.

What does this mean? Less leverage means fewer shares bought or sold. Reducing risk means fewer shares bought or sold. Longer time frame positions means few trades. This all adds up to less volume, which really screws up those people that compare price and volume to make their market calls.


Chart Trader said...

Good observation on the reverse H&S. I think we are headed back to the July highs. Window dressing for Q3? Too many people 'short' too.

Paul Stiles said...

Looks like we are already there, which is simply amazing. I guess we recently had a huge reduction in the short interest on the NYSE, some 5%. I just hope the bears haven't given up yet.