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The Morning Cup of Jo


It is what it is, let's not try and make it something it's not.


Trademark Pending

Good Morning from Ollie's Diner for another 'Cup of Jo.' Because of the overall market picture and a conversation I had a few days ago, this morning I thought it apropos to discuss my overall view of technical patterns in relation to emotions.

The formation of technical patterns is not an exact science, especially when what you're looking at is not complete. As they say, "Hindsight is 20/20." Nevertheless, many times techies look at a chart and try to force a square peg in a round hole. In other words, try and place a technical pattern on every chart they look at. In my humble opinion, this can be very detrimental to your trading. Why? Because, not every situation disseminates a pattern and trying to force the matter can result in a gross misinterpretation of the next potential move.

However, I bring this point up because all of the three sisters are starting to show prospective bottoming patterns and a few days ago an extremely zealous and novice broker/technician mentioned to me that, "All three sisters are showing an inverted Head and Shoulders pattern. Therefore, with this technical unification the market is at a bottom." Ya gotta give the guy credit; he's definitely searching for a direction. I actually applaud his thought process. Which brings me to my point... In the technical world you need to separate your desires from reality, if you don't, it can be tremendously devastating. Trust me, being a market technician for over 9 years, I know.

Once you allow your emotions to get involved in determining technical patterns, the screens become incredibly ambiguous. You must, at all costs, keep your emotions out of your interpretations. For example, take a look at Professor Reamer's analysis. He is a superb market technician and you will never see him speak, nor write, about his emotional stance. With his compilation of the Fibonacci retracements, Elliott wave theory and DeMark indicators, he is a technician of exacts who weighs the risk/reward scenario of every potential move.

On to the three sisters... First I'd like to say I agree with part of the analysis by the young broker. "The markets are showing sings of a potential bottom." Furthermore, it is also good they are doing it in unison. But let's take a closer look. I'll start with the Dow.

My young friend was correct. The Dow is currently forming an Inverted Head & Shoulders pattern and is in the midst of making the second shoulder. Also, the MACD has just crossed back to positive. These are all positive road signs to what may transpire if the neckline is broken. Conversely, in a picture perfect situation, the second shoulder nominally doesn't have the Stochastic reach new oversold levels. We all know nothing is ever picture perfect. On another note, the pattern is somewhat slanted. This is okay as long as we realize that the more horizontal the pattern, the more reliable it is.

WONDA Copyright 2004 William O'Neil + Co., Inc. All rights reserved

Next is the SPX. The SPX is not in fact showing an Inverted H&S pattern, but a potential Double Bottom. Also apparent on this chart is the MACD cross, another positive road sign. Again, the stochastic has reached an extreme oversold level versus the 1st bottom.

WONDA Copyright 2004 William O'Neil + Co., Inc. All rights reserved

The last of the three sisters is the Nasdaq. This chart is showing a potential Triple Bottom pattern. I have actually heard this referred to as a triple top. My belief is that a triple bottom is the same as a double bottom with one more bottom. However, whatever you decide to call it, there it is. Notice again the MACD cross. Here again, the pattern is somewhat slanted and the stochastic has reached a new oversold level.

WONDA Copyright 2004 William O'Neil + Co., Inc. All rights reserved

All three of these patterns are bottoming patterns and all similar, but yet not the same and not having confirmation of a Stochastic Divergence - which is not necessary, but important. In retrospect you may be asking, "What's the difference? They are all bottoming patterns." I believe, since they are not complete, they have much room to go before reaching absolute. There are still many different scenarios that can play out from here. Granted, the Risk/Reward of investing "Long" has greatly improved, but I wouldn't go blindly. What's the ole' adage on Wall Street? "Pigs get fat and hogs get slaughtered."

If I never said anything to my young friend, could he have been right for the wrong reason? Absolutely. But, what would that do for his skills and what might happen the next time this situation arises? I believe part of technical analysis is an art, but I also believe, first and foremost, it is a science. {The science being the true definitions of patterns and the art being the interpretations of those patterns.} If we, as techies, are to trust in patterns and their potential moves once a breakout occurs, why is it we are so willing to construe patterns that aren't really there? Hope?! Well, in the words of William O'Neil, "The market does not care who you are or what you hope for."

Joey, thanks for the conversation and I hope this helped!

Until next time...


No positions in stocks mentioned.

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