Two Treacherous Technical Patterns on the S&P 500

In early May 2018, there was a good deal of talk of a descending triangle on the S&P 500, following a series of lower lows and lower highs.

And that’s a problem.

That’s because a descending triangle -- a consolidation price pattern composed of lower swing highs pushed lower by an established downtrend made up of a series of swing lows – can lead to a breakdown in the markets. In fact, about two-thirds of the time, a descending triangle pattern can lead to lower prices, and greater fear of a more sizable shift to lower lows in the market.   

Let’s look at a chart of the S&P 500 for example with trend lines drawn.

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One line is drawn horizontally connecting lines of support. The other connects the downward sloping price peaks atop. Once you connect these you begin to spot the triangle. 

Fear of further downside then begins to appear if the price of the index begins to make a sharp, meaningful move below the lower line of the triangle. For example, if we look at the S&P 500 chart above, we can see that our line in the sand at the lower line of the triangle sits at 2,550. Should the index shatter that line of support, an argument could be made for a potential move to the next area of support on the S&P 500 around 2,500.

However, if the S&P 500 were to bounce from 2,500 and break above the descending line, an argument could also be made for a breakout to the upside from the pattern.

Of course, it’s always a wait and see with technical situations such as these.

The other indication of potential lower lows on the S&P 500 sits at the 200-day moving average. As you can see here, the index managed to stay above that line or bounce off of its many times since the middle of 2016. However, in early May 2018, signs of a breakdown were magnified as the index broke that trend line to the downside.

Should the index fail to catch support just under the 200-day – as it did in early April 2018 – a bearish argument could be made for a test of 2,550, near-term.  

This is the exact reason why it’s essential to pay close attention to technical set ups.

By spotting them early, you set yourself up for the potential to make money on the short side.

However, don’t panic…

Sure, the market was a mess in the early days of May 2018.

But we have to remember to remain calm because markets are still very resilient.

The last time we fell below the major averages was in late 2015, early 2016, as the Dow fell from 17,750 to 15,500. The time before that, the Dow fell from 18,000 to 15,500. And the time before that, the Dow fell from 13,000 to 6,500 in the subprime fiasco.

Once fear subsides, upside has historically been significant. The key to doing well even in pullbacks is to remain calm. The last thing you want to do is sell everything. By doing so, you miss out on the resiliency rally that follows.

Plus, look at what happens after an extreme bout of fear, technically.

Let’s go to the sell off from 17,750 to 15,500 for example. At the peak of fear, the Dow Jones fell to its lower Bollinger Band (2,20) with severe bearish extensions on relative strength (RSI), MACD and Williams’ %R (W%R).

Remember, even in absolute times of panic, money can be made.

  • As even Warren Buffett will tell you, “Be greedy when others are fearful.” 
  • As Baron Rothschild would tell you, “Buy the blood in the streets.” 
  • And as Sir John Templeton would tell you, “Buy excessive pessimism.” 

Don’t fear the markets on sell offs. Wait out the fear and take full advantage.

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