Saturday, September 25, 2010

S&P500 Reverse Head and Shoulders in Action

I'm going on a business trip to Los Angeles for a week, flying out tomorrow morning.  So, just a quick one before I leave...

The above chart is that of the S&P500 index.  A reverse head and shoulders pattern has just been confirmed, with the index breaking above the "neckline".  You can expect the index to reach 1230 points as a target.  Note that this is a purely technical indicator and has no fundamental basis, whatsoever.

So, how does it work?  Technical analysis is loosely connected to behavioural economics.  From behavioural economics, we know that people tend to conform to the general populace and is loss averse.  In the case of technical analysis, since investors believe other investors look for technical indicators, they would not want to miss out on this great run, and decides to jump back into the market.  Therefore, the pattern is almost a self-fulfilling prophecy because this new money flowing in drives the prices up further.

Depending on what your outlook on the overall market is, it may be a good time to either jump back in (if you believe the past few months has been a correction), or to take profits/cut losses (if you believe a double-dip is in the works).  What do I think?  I'm undecided until I see the S&P500 breaks above the 1220 point resistance.  Proceed cautiously!