DJIA Chart: Classic ‘Head and Shoulders’

Recent market volatility is clearly unnerving.

I believe the volatility is exacerbated by the general decline in broad based participation in the markets over the last few years. Additionally, the growth in derivatives, both within the equity and fixed income markets, has served to accentuate the swings.

I described these swings and the accompanying spike in volatility as the equivalent of an Adult Swim Only a few days ago when I wrote, What Caused the Market Meltdown?.

What are the implications for a market in which there is a lack of broad based participation?

To an ever increasing extent, professional traders study the charts and perform technical analysis to determine likely levels of support and resistance.

On that note, let’s navigate and review a chart of the Dow Jones Industrial Average which takes us back 5 years and provides a fabulous view of the recent cliff dive along our market landscape.

What are the key points of interest, or dare I say, the pronounced peaks and valleys for the DJIA over this time period?

>>October 9, 2007 14164 New all time high on the Dow

>>July 2, 2008 11215 Dow closes more than 20% below its Oct. 2007 high – defining an entry into a bear market.

>>February 27, 2009 7062 Dow closes at post 1997 low – more than 50% below its Oct. 2007 high.

>>June 28, 2010 9686 Dow retraces approximately 38% of its total downward move, a key Fibonnaci retracement level. Also a level from which the market lurches higher two months later when Fed chair Bernanke announces QE2.

>>April 25, 2011 12,810 Dow makes a high for the entire move, proceeds to trade sideways until three weeks ago it cliff-dives from the 12,700 area. If we take a step back and look at the chart of the DJIA we can see a classic head and shoulders formation developing.

The left shoulder is structured from early 2009 until August 2010. The head is completing its formation currently.

A key level to monitor in the finished construction of the head is in the range of 10,200-10,300. If we were to take that range out, the DJIA would be 20% off the highs of the move seen this past April and officially enter into bear territory.

My sense is that we will test that range and move sideways for a period prior to taking it out eventually and constructing the right shoulder.

How long might it take for the completion of the head?

Well, in large measure we have already completed it. Let’s focus on the shoulder.

The left shoulder was formed over the course of approximately 18 months. Who is to say how long it may take to construct the right shoulder. The first level we watch is that 10250.

What else should we monitor closely?

All eyes and ears will be on Jackson Hole, Wyoming later this month when Ben Bernanke speaks at a Kansas City Federal Reserve annual conference. Every economist, trader, portfolio manager, and central banker in the world will watch and listen to each and every word emanating from that conference to see if Ben provides ‘more juice’ for the equity party that was halted very abruptly over the last three weeks.

Pack lightly and navigate accordingly.

About Larry Doyle 522 Articles

Larry Doyle embarked on his Wall Street career in 1983 as a mortgage-backed securities trader for The First Boston Corporation. He was involved in the growth and development of the secondary mortgage market from its near infancy.

After close to 7 years at First Boston, Larry joined Bear Stearns in early 1990 as a mortgage trader. In 1993, Larry was named a Senior Managing Director at the firm. He left Bear to join Union Bank of Switzerland in late 1996 as Head of Mortgage Trading.

In 1998, after 15 years of trading and precipitated by Swiss Bank’s takeover of UBS, Larry moved from trading to sales as a senior salesperson at Bank of America. His move into sales led him to the role as National Sales Manager for Securitized Products at JP Morgan Chase in 2000. He was integrally involved in developing the department, hiring 40 salespeople, and generating $300 million in sales revenue. He left JP Morgan in 2006.

Throughout his career, Larry eagerly engaged clients and colleagues. He has mentored dozens of junior colleagues, recruited at a number of colleges and universities, and interviewed hundreds. He has also had extensive public speaking experience. Additionally, Larry served as Chair of the Mortgage Trading Committee for the Public Securities Association (PSA) in the mid-90s.

Larry graduated Cum Laude, Phi Beta Kappa in 1983 from the College of the Holy Cross.

Visit: Sense On Cents

2 Comments on DJIA Chart: Classic ‘Head and Shoulders’

  1. This analysis appears to be a classic case of retrofitting a pattern to historical performance while ignoring the underlying black swan event. The author manages to somehow completely ignore the downgrading of US debt as having anything to do with market reaction. Instead he claims the downturn is instead the formation of the head. This analysis completely ignores a first-time event of global impact whose chance of occurring was deemed statistically insignificant not that long ago. The only way this pattern identification did not just completely ignore the biggest singular macro-economic event in decades is to assume the entire market calculated the probability of the downgrade as being at least “probable” all the way back in early 2010, when the left shoulder was topped. Clearly the market did not as it would never have formed the head in the first place. This is simply a classic case of ignoring a global economic black swan type event and retrofitting the market reactions to a pattern in order to support a prediction.

    • Michael,

      You would seem to believe that there is absolutely no use in making any type of case for technical analysis. I would think you would be wrong in doing that.

      Markets trade based upon fundamentals, technicals, and psychology.

      In regard to your comment about a black swan type event, I would disagree that the downgrade rises to that level but I will defer. The simple fact is I did highlight the reasons for the selloff in my embedded link, What Caused the Market Meltdown?

      Enjoy.

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