In last week’s article, I commented extensively on the presence of inside bars on numerous charts — including all three major U.S. stock indexes — and why they’re so important.
I highlighted the phenomenon that these small, innocent, benign looking inside trading bars are often the catalyst for dramatic turns. That’s because small bars represent a “coiling” of energy before it’s released violently in one direction or another. Sometimes small inside bars are continuation patterns for trends.
But other times — like last week — they’re warning signs of trend reversals instead.
After an initial “head-fake”earlier last week where the indexes rose to all-time highs, matters were quite different by Friday. At the end of the week, all the indexes sold off in fairly dramatic fashion and closed at their respective weekly lows. The tech-laden Nasdaq got whacked the hardest and dropped 3.2%.
The action was noteworthy not just for the drops, but for the price points where they took place. The damage occurred at what look to be potential double-top (and very bearish) price patterns. That could indicate notable stock market corrections from current levels.
Let’s look at the S&P 500 first.
Calling a double top in this index is a bit of an early call at this time. After all, you normally need to wait until the neckline of the pattern is breached before the pattern is confirmed.
However, the possibility of a double top is well worth considering at this point. That’s because I’m always looking for opportunities.
And there’s no better place to look for opportunity than when you see a sudden and dramatic change in price direction. The S&P has been going up for a long time, but now a shock has been administered to the index. That’s the kind of sign that leads to large moves.
But before I dwell further on that, let’s look at the DJIA (Dow Jones Industrial Average) too.
Just like the S&P, the DJIA made an all time new high and then closed on the low with a very bearish key reversal.
It’s not just the key reversal itself that’s bearish, of course. The fact it happened at a major resistance area is doubly important.
It could in fact be the sign of a huge downward move in the near future. The inside bar was the catalyst — remember that inside bars represent a lack of follow through after a period of momentum. Sometimes the market just needs to catch its breath before continuing, other times inside bars herald a reversal. One so big the entire trend changes.
Now it seems the DJIA looks set to drop. This won’t necessarily happen right away though. For now, see how the market behaves. There might be a delay before the DJIA (and the S&P500, for that matter) start to descend in earnest. After all, they’ve been going up relentlessly for some time and the market might slide sideways for awhile first.
In contrast, the NASDAQ 100 looks a lot more likely to move down quickly. It had the roughest week of all three indices with a large key reversal that set new lows for the past several weeks:
You can see where the double top at the high was tested before the dramatic selloff.
Because key reversals tend to point in the direction the market wants to go, I think we’re going to see a near-term drop in tech stocks with a reversal this violent. The price could re-test the bottom of the channel and possibly plunge even lower. After all, the month of October is often known as the month of surprises for the stock market. And the NASDAQ looks very vulnerable in the next few weeks.
So how do we take advantage of that?
The ETF (Exchange Traded Fund) called QQQ tracks the NASDAQ 100. Here’s a daily chart:
You can see the clear double top here. Unlike the potential double tops on the weekly charts, this one is a completed double top. One I like to call an “M-Top” because of the shape. Note that you can’t have an M-Top without reaching the neckline of the pattern. That’s what confirms the double top pattern.
In addition (it’s hard to see on this chart but hopefully you can spot it anyway) there were two bearish key reversals in the second top where made a high and then closed on the low. And they also occurred right at the resistance area formed by the first top.
As the key reversals happened during the week, I decided to play this on the short side by buying some 183 puts. They were available for just 20 cents.
But with the sharp QQQ drop as the week ended, my 20 cent puts rocketed to $2.
That was an immediate 10-1 gain.
Have YOU ever made 10 times your money that fast?
I think it’s a powerful demonstration of just how lucrative pattern trading can be.
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