Head and shoulders setup on major indices?

Could the Dow Jones and other major indices be setting up for a head and shoulders style technical-driven sell-off?  It will depend on what the Fed has to say next week, but also on the rate of deterioration in Europe and other news-driven event risk.

For the pattern to play out, some more upside may occur, but not further than about 11,600.  The downside target, should the Dow slip below 10,600, would be approximately 10,000, but if the sell-off accelerates we could see a dip to the 9,600 to 9,800 level.

Which way the market goes is uncertain, but on the weekly charts the recent technical damage has created the potential for further downside risk.  I began aggressively taking equity positions off the table in July, with the exception of some silver and gold miners.  I encourage all readers to exercise extreme caution in the coming weeks and months as the global equity markets are extremely volatile, illiquid and therefore less volume can create much larger percentage moves.

S&P 500 head and shoulders pattern confirmed

A repeat performance of the bear market rally breakdown seems to be in the works now.  The first downside target is 875, then I believe we could see a large sell off to around 775-800 if that level breaks.  After that a retest of the lows is almost certain.  The image below illustrates the pattern on a three month / one day bar chart.  There may be some support at the 200 day moving average around current levels as the market is oversold.  A bounce before continuing downward is not out of the question.

S&P 500 head and shoulders pattern

US dollar index showing head and shoulders

The US dollar index is forming an all too familiar pattern.  This is certainly a result of wreckless monetary policy turning deflation in to a potential stagflationary situation. At this point we recommend purchasing commodities (DYY is a good ETF because it is 2x leveraged and well diversified) and other currencies while there are reasonably priced opportunities.  We like the Euro and Yen for this trade.

US dollar index

US dollar index shows head and shoulders pattern

The courageous may consider purchasing commodities stocks as they will likely participate, but the future of the equities market is not necessarily certain as the recession is deepening.  Today’s unemployment claims were higher than the expected 525k at 573k.  That is a very bad sign that the worst is far from over in terms of how many layoffs we can expect.

Nasdaq one day chart: head and shoulders

We are seeing confirmation of a head and shoulders pattern on the NASDAQ composite. This pattern is potentially very destructive to the rally that has taken place thus far. If you are still long this market, a stop slightly below 880 on the S&P or 1550 on the NASDAQ composite is wise, as that seems to be the only level holding back a collapse of the uptrend.

Watch this trend closely because the weekly chart on the NASDAQ composite shows the same pattern forming, meaning we could be retesting our lows in short order if it traces out the right shoulder and breaks below the neckline.