SPX has been tracing out a channel over the past several months, but its RSI has clearly formed a rising wedge. The divergence begs the question: “which will prevail?”
Regular readers know I’m a fool for chart patterns in general and RSI chart patterns in particular. But, that’s a solid channel that’s withstood some pretty nasty headlines. And, as we’ll see below, it is exactly parallel to the channel that guided the Dec 2011 to May 2012 ramp. We’ll see if we can find some corroborating evidence to guide our forecast.
continued…As I wrote earlier today, we finally tagged the fan line from 2007 today. It’s marked as the red, dashed line above. While it doesn’t necessarily signal a major downturn, we should expect at least a reaction here.
Next, there’s the harmonic picture. SPX recently reached the Fibonacci .886 retracement of the 1422-1266 plunge — a Bat Pattern — at 1404. This was also the exact target of the recent inverse H&S pattern. We seen plenty of dithering over the 7 days since, but no real reaction just yet.
Harmonic patterns overshoot (and undershoot) all the time, so today’s 1410 high still represents part of the target range — especially when there’s another important target (the fan line) in such close proximity.
SPX also reached the neckline of the previous H&S pattern today, shown above as the white dashed line. As such, the action since early May could be viewed as a big, somewhat complex back test.
I wrote about this on May 4 [see: Random Walk, my A$$] and several times since, thinking it would eventually be back tested after we came back from the June lows. But, I expected the rebound would be as swift as the plunge — never envisioning the whipsawing back and forth of the past nine weeks [see: On Track.] It was this churning that was primarily responsible for the analog finally failing after working so well for two months.
The last issue we’ll examine is the RSI chart. Rising wedges often break down at the .618 mark (in terms of time from inception to apex.) Wedges that surpass this mark typically break down at another harmonic milestone such as the .786 or .886.
Applying a Fibonacci time ratio grid to the RSI shows that the peaks have by and large fallen on important Fibonacci levels. Up until the end of July, each subsequent drop landed on a trend line (TL # 7) parallel to the upper bound (TL # 3) of the rising wedge.
On August 2, it tagged the lower bound of the wedge (TL #5) instead. If the harmonic pattern holds, we should see another tag of TL #3 on or about Aug 22 (the .886 Fib) — likely meaning another tag on TL #5 in the interim. The alternative case is a drop to TL #7 to continue the channel formed between TL #3 and #7.
The lesser drop probably equates to 1380 or so, a tag of the last fan line from 1422 (the thin purple lines.) The greater drop probably takes SPX down to the lower channel bound — currently at 1366. The complicating factor is that Friday is OPEX — which would typically prevent a large drop.
We’ll watch how the next few days unfold, and try to flesh this out a little more tomorrow. If the forecast fails, we’ll know soon enough. I’m prepared to pull the plug on my short position if SPX exceeds 1415 or so.
But, I don’t think it will. The thin red TL from Feb 9 should help keep any further ramps in check — at least for the time being.