Head And Shoulders Pattern:  Look Out Below?

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That’s a pretty swift drop.  And it’s especially disappointing considering the broad indexes were just trading near 52-week highs less than two weeks ago.

The severity of the sell-off paints a very interesting technical picture…


As you can see, the S&P 500 swan dived from the 1,340 area.  It’s as if someone yelled “fire!” in a crowded theater and everyone rushed for the exits at once.

But on further review, you’ll see a classic technical pattern is forming.  This widely recognized pattern is marked by the red letters at the top of chart.  On the far left and right, you’ll see an “S”, and in the middle of the chart, you’ll find the letter “H”.

What do all these letters stand for?

I may sound like a Sesame Street rerun, but the letters point out a classic “head and shoulders” pattern.  The S’s point out the shoulders while the H signifies the head.

What’s the big deal about a head and shoulders pattern?

It can be an ominous sign of impending stock doom.  You see, when this pattern forms after a long run up in stocks, it can signify a long-term top in the market.

See the red line at the bottom of the chart?  That’s the ‘neckline’ of the pattern.  If stocks break below that area, it’s a clear technical signal that the long-term bull run is over.

So are stocks guaranteed to go lower from here?

As compelling as this bearish pattern is, it doesn’t always turn out like it’s supposed to.

Take a look at this chart…


As you can see, a similar head and shoulders pattern formed in 2010.  Back then investors were just as jittery as they are now, if not more so.  The infamous “flash crash” had just fried many investors’ nerves and sentiment was strongly bearish.

But instead of the market breaking down through the neckline and falling into an abyss… stocks rocketed higher for months.  Investors unleashed a buying spree that took stocks higher right into 2011.

So what should you do?

Keep a close eye on the 1260 area- the neckline of the pattern in the first chart.  If stocks break and close below that important support area, we could be in for a nasty ride this fall.

But don’t jump the gun…

Stocks are already heavily oversold on a short-term basis.  And that means we’re likely to see a rally in coming days.

What’s more, unless we get horrendous news out of Europe in the next few days, this year's head and shoulders pattern will likely turn out like last year's.  In other words, don’t be surprised to see another strong rally into the end of the year.

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