Is the Market showing signs of Reversal?

Weekly Market Report For July 6th, 2009

In this week's report we'll take a look at a common reversal pattern, known as a head and shoulders, which is starting to form on the charts of several major indexes. For those who need a quick refresher, you'll find that this pattern must go through four main steps to signal a reversal. The first step is the formation of the left shoulder, which occurs when the security reaches a new high and retraces to a new low. The second step is the formation of the head, which occurs when the security reaches a higher high, then retraces back near the low formed in the left shoulder. The third step is the formation of the right shoulder, which occurs with a high that is lower than the high formed by the head, but is again followed by a retracement to the low of the left shoulder. The pattern is complete once the price falls below the neckline, which is a support line formed at the level of the lows reached at each of the three retracements.

As you can see from the charts below, a head and shoulders pattern has formed on the charts of the S&P 500 and the Dow Jones Industrial Average. Luckily for the bulls, the price has not broken below the support level yet, so the rally is still deemed to be intact. It is interesting to note that this pattern is forming near the resistance of the 200-day exponential moving averages, which is also a level that is used by traders to suggest that nearby resistance could become a going concern within the next few weeks. It wouldn't be surprising to see additional selling pressure enter the markets once the prices of these large cap indexes close below their respective necklines.

It will be interesting to see if the smaller-cap indexes such as the Russell 2000 and the Nasdaq, which have broken beyond their respective 200-day exponential moving averages can continue to climb. Given the divergence between the different indexes, the best bet may be way wait on the sidelines to until we see which group will lead the general trend of the markets.