Dow Jones Head and Shoulders Top - Noted but yet to Convince

Markets have continued to fall since my last report, with the Dow Jones currently at 10211 down from 10620, and FTSE 100 at 5163 down from 5262. This is one of the most interesting situations in the market for a long time because of the various contradictions that are now occurring on the charts, together with the level bearish sentiment.

The fall in the Dow since my last column has completed a head & shoulders top area which would normally be taken as a bearish pattern. I don't want to ignore this pattern, and would advocate caution as it has a downside target of 8800, however, I have some doubt about the validity of this one because of its relative position on the chart, or what I refer to as "context". Context is a very important idea that says you don't treat every occurrence of a pattern in the same way, but you have to frame it against the overall picture, i.e. you interpret it in context taking account of the prior movement & relative position and not just the action of the pattern itself. So it's not enough just to say "there's a head & shoulders top so I'm bearish".

In this instance, we are being presented with a head & shoulders top about 15 months after the bull market low. That strikes me as being quite early in the cycle. Another factor is the way that the market went down, breaking the neckline at around 10,000 and then came back up again. A third point is the fact that we are on the verge of an important signal which has a very good track record on key US & UK indices over many years. This is a variation of Stochastic which is very different to the standard version, and it gives medium-term buy signals. In fact we have just had a tentative signal on the UK market.

So it's a very mixed picture. Levels which I identified in my last report were broken, but there was no real follow-through. I sense that the market had a chance to break sharply lower but didn't take it. I also feel that there is an overwhelming bearish concensus. It's a really tricky one to call - and I'm not claiming that I can because I don't think the odds are skewed sufficiently one way or another - but you should be aware of the factors on the other side of the bearish argument. Obviously the market will give us the answer soon enough, but what I'm saying is that if it doesn't break lower as most people expect, then there could well be a rally which catches many people out.

Away from the stockmarket, Sterling (GBP/USD) currently stands at 1.45 against the Dollar which is unchanged from my last report, and against the Euro the Dollar (EUR/USD) is at 1.21, down from 1.23. These charts remain in downtrends, and as I said last time, there's a distinct lack of support on both charts, especially versus the Euro.

Gold is currently at $1226, down slightly from $1232 in the last report. This chart still looks capable of pushing higher and making more all-time highs. The target remains $1300 which is based on the $300 depth of the range ($700 - $1000) prior to the breakout. As always, it's easier to say what a market will do, than to say when it will do it, so there's no timeframe to go with the target.

(c) Robert Newgrosh 2010