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Are Market Patterns Diamonds or Coal?


Beauty is in the eye of the beholder of course but if the DJIA and S&P crack their diamond patterns, Hoofy could find a lump of coal in his stocking this Christmas.


Now there's a look in your eye
Like black holes in the sky
Shine On You Crazy Diamond (Pink Floyd)

Whether we fall by ambition, blood, or lust
Like diamonds we are cut with our own dust.
John Webster

Diamonds may not be a bull's best friend.

A look at the daily chart of the DJIA for the year reveals that the index has completed a potential bearish megaphone or broadening top pattern.

Click here to enlarge.

The pattern is traced out by points 1, 2, 3, 4 and 5. A megaphone pattern is defined by a five point series of expanding higher highs interspersed by lower lows. The resolution of such a pattern typically would call for the last major low, in this case the August low, to be violated.

As you can see with Tuesday's low, the DJIA has wound itself into a diamond as the index tagged a trendline coming up from the August 16th low and the September 10th low.

With Tuesday's low the DJIA now has the distinction of a three point rising trendline. Clearly, only one of two things will play out from this do or die pattern: either the DJIA will erupt from this third higher low or it will buckle if the trendline is broken triggering an Angular Rule of 4 Sell Signal (a break of a three point trendline). That is why the behavior following Wednesday morning's rally is so significant. Not only is Wednesday's early rally the first true rally attempt since the pullback off the high, but the market is in the apex of this big picture diamond.

When looking at possible major inflection points it is obviously important to employ multiple time frame analysis. A look at a weekly chart of the DJIA shows a weekly megaphone and diamond as well.

Click here to enlarge.

Looking at a daily chart of the S&P for the year, we see that the top in July was also in the spirit of a megaphone or broadening top formation.

Click here to enlarge.

Note how the waterfall decline in the summer began on a break of the trendline formed by points A and B. Is this set-up analogous to the position of the DJIA currently as it bounces this morning of a similar trendline?

Now, let's go to a weekly chart of the S&P.

Click here to enlarge.

Note the broadening top and diamond formed by points 1,2,3,4 and 5. Note the steep trendline of support the index is currently perched on. The steeper the trendline, the more severe the decline if broken? The current pattern lies within a larger megaphone formation defined by points A,B,C,D and E. The upshot of it all is that the pattern appears to have completed with last Thursday's Spike and Reversal. But hey, let's all jump into the fray and chase the market because all roads lead to Intel (INTC)? Right?

The weekly chart of the S&P has turned down and accelerated somewhat lower suggesting a possible change in trend. It is interesting that the low of October, so far, is the low of October 1st at 1527.25. If the market should remain above this level going into month end then trade below 1527.25 in November will turn the Monthly Swing Chart down. Any acceleration lower at that juncture, if it should occur, demands caution as the power of this coil, this diamond, is underscored by another diamond embedded within the first diamond. In other words, a facet of the current diamond defines the topping process into the July high which itself was "in the spirit" of a megaphone top in and of itself as seen by points A,B,C,D and E.

The one month and nearly 200 point plunge off the July pattern is testimony to the power of this set-up.

With Tuesday's undercut by the S&P of its 20 dma the index was down a quick 40 points from the 1576 square out off the October 2002 low. At Tuesday's low the S&P has traded 90 degrees down from the 1576 high which is precisely 1536. A 180 degree move off the top equates to 1497, in case you were wondering.

Interestingly, as mentioned above, while a 90 degree move down coincides with the 20 dma, a move of 180 degrees down from the high would coincide with a kiss of the 50 dma by the S&P. The 50 dma is now at 1494 and moving up.

I have mentioned an hourly head and shoulder pattern on the S&P that projects to 1525ish, which, interestingly enough, coincides with the lows of October. A break of the October lows could serve to confirm the significance of the 1576 level.

The point of equilibrium of the big picture diamond is the 1474/1475 which is the mid point between the August low and last weeks high. 1474 S&P also approximates the low of Two-fer Tuesday when Bazooka Ben and Hanky Panky surprised the Street with a slash and burn double-barreled cut in the Fed funds and the discount rate.

Although I don't anticipate a breach of 1474 in October, this is a rapid market which has shown it is best to consider the unthinkable. A move below Bernanke Tuesday and 1474 by the S&P this quarter would show that the Emperor has no clothes. A move below the September low of 1439.30 would carve out an outside down reversal month. A move below the level where the Quarterly Swing Chart last turned down at 1426 would issue a Time Turn Trend sell signal. It would be the sign of the bear.

Of course, as yet this is no confirmation of a change in trend, except the 1576 square out, the cycles coming in on the anniversary of some key highs and lows in history, the 33-day blow off cycle, the history of the fourth quarter in years ending in 7 and of course the megaphone and diamond pattern. I don't want to get too far out ahead of the curve, but the market can turn on a dime, uh, diamond, as we have seen.

In addition some key go to glamor names have carved out some serious distributing days while others such as Southern Copper (PCU), IBM (IBM) and the FXI show what may be daily buying climax spikes and Spike Volume Tops.

Click here to enlarge.

Click here to enlarge.

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The S&P itself is now below the level of the July peak and the March 2000 high seven years ago. Is it a sign of weakness that the index has not truly bettered the peak of seven years ago, a grand double top, or is it a sign that it has plenty of room to run, as some suggest?

Beauty is in the eye of the beholder of course but if the DJIA and S&P crack their diamond patterns, Hoofy could find a lump of coal in his stocking this Christmas.

Editor's Note: Want more of Jeff's insight and trading ideas delivered to your inbox daily? Minyanville is proud to announce that we have launched Jeff Cooper's Daily Market Report, complete with Jeff's day trading and swing trading setups. Email Josh Sander for more details and how to sign up.

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