Patterns That Demand Your Attention

 | Oct 02, 2012 | 6:00 AM EDT
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When I said I thought the market should be selling into an oversold rally, I didn't think it meant one lasting for three hours. I thought it would be fits and starts, and a stretch of at least a few days. Two immediate thoughts come to mind when I see this type of action: First, the market sold off on good news, which is definitely not what the bulls want to see. Second, to me this notion of "chasing for performance" seems to be a figment of the imagination.

Since I reviewed many of the intermediate-term indicators Sunday, I won't repeat them here, except to note that breadth actually stayed rather green throughout Monday's session. Just to put it in perspective, if we added up the breadth for Friday and Monday, the market would show positive breadth by a mere 30 points -- but this occurred as the S&P 500 lost 3 points. If the market hadn't reversed in the way it had, folks would have viewed that as a positive.

However, what I would prefer to discuss today would be all those head-and-shoulders tops, or potential ones. I referenced this pattern last week, before the rally, when I noted that a great deal of stocks were sitting on their necklines. I called it the "Case of the Missing Right Shoulder," and I believed we needed to see a rally in order for those right shoulders to form.

If we look at the PowerShares QQQ (QQQ), we see the uptrend line (in red) has been broken, and the right shoulder is developing above the neckline (in black, beneath the red line). That is what I see in the major indices. In individual charts, often the uptrend line intersects at the neckline -- that is, the uptrend line hasn't broken yet -- which makes a break of that level doubly important. When one line is broken, it's more of a warning. But when two are broken at the same time, you need to pay more attention, since the stock has now done two things wrong.

PowerShares QQQ (QQQ)

Now, let's look at a chart that isn't a technology name and doesn't have a head-and-shoulders top in place: Citigroup (C). Instead of this, it has an uptrend line, and a rather flat line that intersects. As with many banks, the flat line here is similar to a neckline of a head-and-shoulders top -- it denotes the point at which the top breaks. For Citigroup, that spot comes in at $32. A breach below that level would break the uptrend line that has been in place since the summer, as well as the flatter line that connects the two recent spike lows.

I am certain many will argue that Citigroup's top is too small to even fuss over. I would concur that it is small -- but keep in mind that the uptrend line has four points on it, and one of the basic tenets of trendlines is that two points make a line, and the third confirms it. The more points on the line, the more solid the line. So if a stock breaks an uptrend line that has four points, you cannot dismiss it simply because the top is too small. To me, this would mean that rallies back to the underside of the line would fail.

Citigroup (C)

Speaking of the banking sector, this group hasn't done anything wrong yet. But, for all its terrific performance recently, I find it fascinating that the ratio of the KBW Bank Index to the S&P 500 is at a lower high in comparison to its action in the spring -- meaning this ratio had actually been a better market leader then vs. now.

KBW Bank Index vs. S&P 500

For the overall market, I still think there should be another rally attempt later this week, and I still think we should look to sell into it.


Overbought/Oversold Oscillator -- NYSE

Overbought/Oversold Oscillator -- Nasdaq

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