Market Direction Mid Week Update

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A steady selloff on Wall Street that accelerated at the close Wednesday erased nearly all of the sizable gains from the previous day’s session, as disappointing earnings from Disney and a slump among retailers led to disquiet among investors.

In fact, the most recent trading moves have begun to create a bearish reversal, typically described by technical traders as a “head and shoulders” pattern. The pattern is formed when three successive peaks are reached in a charted security. Those peaks are described as the left shoulder and right shoulder, the head representing the highest peak in the middle, and a neckline linking two low points.

Having failed to hold and trade above 2,100, the S&P 500 is on the verge of forming such a pattern. If formed, chart watchers view the formation as a signal that a bearish reversal is about to occur. “If we fail to move above 2,100, and soon, the potential head-and-shoulders can be formed,” said Frank Cappelleri, market technical analyst at Instinet.

“Over the past year, this price action created sloppy-looking charts, but the 2,100 area on the S&P 500 continues to be the most critical spot,” he said. BTIG’s chief technical strategist Katie Stockton noted that until and unless the pattern is complete, it doesn't indicate anything.

“The 20-day moving average rolled over a few weeks ago, which indicates the loss of short-term momentum, but we would need to break below 1,925 on the S&P 500 to call for the next correction that will test January and February lows,” Stockton said.

 “The breadth on the S&P 500 is deteriorating. With each high on the S&P 500, fewer and fewer stocks are hitting their respective highs,” Parets said.

Among the charts that Parets monitors, two others are critical for determining the health of the stock markets, including the dollar-yen pair and moves in transportation stocks.

“We monitor the dollar-yen chart. If the yen strength continues, that’s not good news for U.S. stocks. When the yen spikes, it’s because there is fear in the market,” said Parets, pointing to a strong inverse correlation between the yen and U.S. stocks.

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