What Makes a Top?

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Calgary_02

Sorry to Tim … I drafted this post Thursday pre-market by taking a quick copy/paste from my own blog from my site … the pictures didn't work so Tim could not post it.  I did a follow-up post after the market closed on Thursday so I will add that to the bottom of the original post.  I think it is worth the read so I hope you all enjoy it.

======== Original Post pre-market on Thursday =============================================

So was yesterday's action a warning shot across the bow, pointing to more weakness in the days ahead?  There were plenty of technical reasons why a pull-back in the equity markets was overdue.  I'm not going to go into those with this blog post … I wanted to talk more about what we should be looking for in the immediate few days ahead.

There is an old adage that tops are a rounded and bottoms can be "V" in shape (quick, strong thrusts).  If we are making a top in the equity market, the process should take several days before the real fireworks start.  If all we are doing is making a minor correction on the way to higher levels, we will again do that over several days.

I've gone over how to monitor a change in direction with earlier posts, so I won't re-hash that.  What I'm going to do with the rest of this blog is to try and look back at a recent period of topping action to give people a reminder of what the next few days could look like.

It is very rare to find any two periods in time to be identical, but they often will look alike.  So having that caveat out there, I would like to look more closely at the topping action from back in April 2010.

Now the action in April 2010 came at a different spot in the larger trend … just as an example of that, the April rally end came after only an impulsive move that was 54 days long.  The move off of the July lows on this thrust is already at 138 days.  QE2 has been very good for investors.

Enough with the PG movie warnings … how was April's topping action??

 


The following chart shows the April topping action after the first "shot across the bow" day that could have happened in the equity markets yesterday.

SPY_Jan20, 2011_Topping_01

Here is the current chart on the SPY … if you squint, the "kick-off" candles kind of look similar.

SPY_Jan20, 2011_Topping_07
 

Going back to April 2010, what happened to the market the "day after"?

SPY_Jan20, 2011_Topping_02

Back in April 2010, the market breathed a sigh of relief when the losses were limited to that first kick-off day and spent the next several days grinding higher, trying to get back outside that big bearish engulfing candle.

SPY_Jan20, 2011_Topping_03

Notice that last candle … it pushed out the top of the range and then closed back inside.  I wonder if the market rejecting the price area above the bearish engulfing candle could mean anything??

SPY_Jan20, 2011_Topping_04

Well, the market showed us that it needed/wanted to go down.  This "confirmation candle" actually engulfed all the range since the kick-off candle and actually closed below the range … that was your all clear sign to be short the market.

SPY_Jan20, 2011_Topping_05

Nothing goes straight down though – it took 4 more days to break the lower end of the confirmation candle's range.  Then we had the "flash crash".

Conclusion:

The point I'm trying to make is that topping action takes several days … the key thing to look for is the big bearish engulfing candles … when you get these, pay attention to the extremes.  A break outside it's range will tell you the market wants to head in that direction.

SPY_Jan20, 2011_Topping_06

======= Follow-Up Post Thursday Post-Market ===============================================

This morning I posted a blog in which I discussed what to look for as we go forward in terms of looking for a potential top in the SPY (see earlier post).

One of the charts I posted was a picture of the first day after the possible "shot across the bow" …

SPY_Jan20, 2011_Topping_02

Notice how in April, the SPY bounced off of the 20ema and finished the day in the previous day's range.

Below is the daily chart after today's close.

SPY_Jan20, 2011_Topping2_01

The candle today was not as powerful looking as the one in April, but it is doji like (classic reversal candles) and it ended the day near the top 1/3 of the candle.

Stay tuned for tomorrow … if we have a hard selling day tomorrow then I think that would be very bearish.  That is not as likely since tomorrow is OpEx day which tend to be pretty muted in terms of the size of the range for the day.  There have been on occasion, trend down days on OpEx days, so anything is possible.

Cheers … Leaf_West

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