Stocks are Facing an Important Test
I have been expecting a bull market correction for about a month, but it's not been as deep as I expected. Now, however, several indexes have completed small bullish two-bar reversal patterns on the weekly charts. If they work, that would be a characteristic of a bull market, since they would be pro-trend signals. On the other hand, failure of these formations would represent the kind of action to expect in a bear market. For the record, a successful pattern is expected to have an have an influence on prices for between 5-to-10 bars. I am focusing on weekly bars in this piece, which would imply an effect between 5-10 weeks.
Examples of Pro- and Contra-Trend Signals Using the SPDR Financials
By way of an example, Chart 1 displays three patterns for the SPDR Financial ETF (XLF). The first is a pro-trend (Bullish) three-bar reversal. It is a requirement that all one- and two-bar patterns be confirmed by subsequent price action. In this case, the crossing of the 10- and 52-week MAs was sufficient, and the pattern more than delivered with a multi-week advance.
The second pattern is a two-bar reversal that formed last fall. These patterns open up near the low of the first bar and close near the high. The second bar opens near the previous close and closes near the first bar's open, guaranteeing that all who bought during the two weeks of trading come home with a loss. This pattern had a small effect on prices, but only for about four weeks. It failed because it was a contra-trend technical event.
The third pattern formed last week and is an outside bar. Outside bars are characterized by the fact that their trading range exceeds that of the previous bar. Note that the close was very near the high, indicating buyer dominance. This is a strong signal because the bar is wide, reflecting a big battle between buyers and sellers, but also encompasses three bars in addition to its predecessor.
If it succeeds and pushes the XLF to new highs, such action would be consistent with an ongoing bull market for financials, which is what I would expect. On the other hand, should the outside bar fail, that would be more characteristic of a primary bear market. Having established some of the basics, it's time to explore the price action of some leading averages.
One- and Two-Bar Patterns in the Major Averages
Chart 2 features weekly bars for the S&P Composite. Last September, the Index formed a bullish two-bar reversal. Its cancellation was later confirmed with a break above the green resistance trendline. A similar pattern has formed in the last two weeks. Since there are no obvious resistance trendlines, this pattern really requires a new price high for confirmation. The pattern would then likely serve as a platform for a significant extension to the rally.
Chart 3 shows the same period in weekly candlestick format. An engulfing pattern formed last summer. However, because it was a contra-trend signal, there was not a lot of downside follow through. Fast forward to mid-January and we see another engulfing pattern, this time a pro-trend one.
Chart 4 initially features a failed dark cloud cover for the NASDAQ Composite. These patterns occur when a long white candle is followed by a black one, which opens with a gap and then closes more than halfway down the real body of the white candle. In this case, the pattern failed to "work" largely because it was a contra-trend signal. The second event took place in January and is a bullish piercing white line, the exact opposite of dark cloud cover. If, as the majority of the evidence suggests, the bull market is intact, this pattern ought to confirm it by launching a rally of sufficient power to result in significant new highs. If it doesn't, that will be a bad sign.
Of all the averages, I find the Small Cap Russell 2K (IWM) to be the most interesting technically. That's because there is a conflict between the monthly and weekly bars. Chart 5, featuring monthly bars, indicates that the IWM recently broke above key resistance, but that a bearish two bar reversal took the price back below the breakout point, thereby canceling it.
On the other hand, the last two weeks have resulted in a bullish two-bar reversal. The monthly action is more significant, but the weekly offers some hope that it will be cancelled by a move to new highs. If it works, that would be very bullish. On the other hand, should the monthly pattern hold sway, an extension to the recent correction would likely transpire.
Good luck and good charting,
Martin J. Pring
The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Groupof Walnut Creek or its affiliates.
