The Chartist's Dilemma

As a chartist, you know something’s gone haywire when a major, long-term channel breaks down and it results in higher prices. Yet, as every chartist knows, this phenomenon has been a hallmark of the financial markets for the past several years.The S&P futures (ES) offer a very clear example. Like all channels, the rising purple channel above was formed by a series of rallies and setbacks. It ran into trouble in late October when ES dipped below the channel bottom (yellow arrow) but recovered only an hour later. It bumbled along until Nov 9, when it broke down again.This time, however, it formed a Head & Shoulders pattern that suggested an additional 32-pt drop to backtest a key Fibonacci level. In each case, VIX plunged (32% and 41% respectively), algos responded, and the damage was contained.

Intraday dips that drop below a channel bottom are no big deal. They happen all the time and are promptly bought — the new normal.

But, when the dip results in a close below the channel bottom, it has (traditionally) mattered. It matters even more when there are a string of lower lows and closes below the channel bottom such as between Nov 8 and Nov 15.

Fortunately for the bulls, and no doubt quite by coincidence, USDJPY rallied sharply (the shaded area below) at precisely the same time that VIX’s 41% plunge (to new, all-time lows) ran out of steam. The yen carry trade rarely disappoints.

And (another coincidence?) as the initial spike took a breather, VIX took the opportunity to plunge again — this time by a mere 36%.Between the two influencers, and some help from a timely pop in oil and gas, ES had no trouble making new highs and actually rejoining the broken purple channel — at least between Nov 30 and Dec 5.

On Dec 5, it broke down again — but just enough to establish the bottom of a new, more steeply rising channel shown below in red. The red channel has provided support for no fewer than six bounces since Nov 15. And, it has guided ES high enough to rejoin the purple channel multiple times — only to end up dropping the ball.With ES currently up 15 points, it’s backtesting the purple channel bottom . This would traditionally be a potential bearish signal. But, clearly, the previous backtests resulted in higher prices. Is there any reason to believe this one won’t?