Nasdaq bulls saved by the gap
'Head and shoulders' gives bears ammo
By Tomi Kilgore, CBS.MarketWatch.com
Last Update: 12:15 AM ET June 18, 2001
NEW YORK (CBS.MW) - A barrage of brutal body shots has brought Nasdaq bulls to the brink
of bailing out.
In the meantime, a gap in the charts
made back in mid-April has given bulls a
convenient place to set up camp. But a
classic reversal pattern -- the "head and
shoulders" -- has given the bears a
reason to be optimistic.
Meanwhile, Robin Griffiths, chief
technical analyst at HSBC Securities, is
not overly concerned. He feels the bear
market in the Nasdaq Composite ended
on cue on April 4, as part of a 14-month
cycle, and recent gyrations are what
can be expected after such a steep
decline.
Where's the recovery?
Having companies warn of shortfalls is
expected during the so-called warnings
season. But the magnitude of the
expected misses and the cost-cutting
measures that are being taken,
especially among some high-tech
heavyweights (see Nortel and JDS
Uniphase stories), are taking their toll
on the fragile psyche of investors. So
much so that the market is now
interpreting weak economic data to
mean that a second-half recovery may
not materialize, instead of as a sign that
more rate cuts would coming to the
rescue.
As a result, the Nasdaq ($COMPQ: news, msgs, alerts) has carved out a rather bearish pattern.
Head and shoulders chips away at uptrend
The "head-and-shoulders" pattern consists of three peaks, with the first and third peaks roughly of
equal height, and with the second one the highest. A "neckline" is line of support formed by the dips
between the three peaks, which are typically at about the same depth.
The Nasdaq took a little breather from a sharp one-month rally after reaching a high of 2,232.66 on
May 2, creating the first shoulder. Refreshed after dipping to a low of 2,052.41 on May 14 (nearly
equaled on May 16 at 2,057.99), bulls stretched ahead and were successful in claiming higher
ground. The May 22 high of 2,328.05 became the top of the "head."
So far, so good. Not only did the higher high show the bulls that hard work would pay off, the timing
of the move gave them guidance as to what slope their upward ascent would take.
The retrenchment and subsequent bounce, however, was alarming in two ways.
Second dip breaks a trend
Take out a ruler and line up the April 4 low of 1,619.58 with the May 16
low. Extending the line gave bulls an indication of where they would find
support in halting the bears' next counterattack. When the slide off the
top of the 'head' stopped at 2,170.58 (on May 29), it forged a third point
on the "trendline," and gave bulls an idea of the pace at which to
proceed. The bulls' newfound confidence proved fleeting, however, as
bears overran them on the very next day.
Dazed and confused, bulls quickly looked to the most recent lows for an
area to take a stand. It worked, and the Nasdaq bounced off the May 30
low of 2,077.98, which was about equal to the May 14 and May 16 low. Little did they know what
they were creating was an even more ominous reversal pattern.
After a trendline is broken, you typically see a period of consolidation where the market will attempt
to reestablish the old trend. If the break is true, the old trendline will act as resistance (or support).
Broken trendline stops bulls cold at second shoulder
The rally off the second dip made it as high as 2,269.58 on June 7 (and 2,263.75 on June 8), close to
the high made back on May 2. But the failure to make a new high suggested the bulls' strength had
been sapped.
The rally also failed to reclaim the old trend, and instead marked points on what has become a
resistance line. Bears took advantage of the opportunity and, as of last Friday, drove the Nasdaq
down for six consecutive sessions.
Draw a line connecting the lows of the first (May 14's 2,052.41) and second (May 30's 2,077.98) dips
to see where the 'neckline' is. The Nasdaq opened (at 2,100.74) below that line last Thursday,
confirming the "head-and-shoulders" pattern. Bears maintained control that entire session, a and a
close (2,044.07) right at the low (2,043.36) shows how bears maintained control the entire session.
Scrambling for help, bulls turned to a "gap" in the charts made back on April 18.
Saved by the gap
"Gaps" are made when a day's low (or high) does not overlap the previous day's high (or low). Upside
gaps are viewed as supports when revisited because bears that sold ahead of them will be happy to
break even given a second chance. And the entire blank area will remain support until it is completely
filled on a closing basis.
Friday's fall stopped (at a low of 1,992.39) within the opening between the April 18 low (1,995.91) and
the April 17 high (1,941.57). Until the bears can get the Nasdaq to close below 1,941.57, bulls will
still have hope.
The next level of support is between 1,868 and 1,890. The
bottom end of that band is defined by near-identical lows on
April 12 (1,868.76) and April 17 (1,869.34), which
coincidentally was within the gap between the April 11 low
(1,884.95) and the April 10 high (1,868.10).
The top part of the support band is the 61.8-percent
retracement of the rally off the April 4 low (1,619.58) and
the May 22 high (2,328.05). An ancient Italian
mathematician wrote about a numerical ratio (0.618) that he
discovered to be prevalent in natural systems, including the
breeding pattern of rabbits and the spiral of a snail's shell. Chart watchers believe that the market is
also a natural system, and therefore if a pullback falls short of this 'golden ratio,' the original move
remains intact. Bulls will undoubtedly fight hard to defend this level, because a failure would suggest
a return to 1,619.58.
2,100 or bust
If the gap gives the bulls the ammunition they need for a counterattack, initial resistance can be
expected at just above the 2,100 level. That's where the "neckline" comes in, and is also the bottom
of a downward gap between last Thursday's high and Wednesday low (2,121.38).
After that, the June 6 high (2,269.58), which was nearly matched on June 8 (2,263.75), will be wear
bears draw the line.
Griffiths believes this scenario is more likely. He is one technical analyst that feels the
head-and-shoulders pattern is not a totally reliable pattern. The fact that they are so well known by
chart watchers and traders alike means they have been anticipated, and may dampen the negative
effects. Instead, Griffiths believes the end of the bear market will eventually take the Nasdaq up to
2,700, and possibly up to 3,000, before a real correction takes hold.
Gruß Dr. Broemme
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