Predicting Major Market Moves By Detecting the Smart Money
Head and Shoulders
While this pattern is harder to recognize for many beginner traders, this pattern is one of the most highly probable and profitable bearish patterns to occur in a bull market. Normally signaling the top of the market is what makes it so effective. This is a pattern designed to fool investors and traders into thinking the stock is making new highs resulting in investors being lured into buying the stock right before it begins its downward decent.
A head and shoulders pattern is characterized by a stock creating a symmetrical triangle up and down forming the left shoulder. This is followed by a larger symmetrical triangle representing the head and then a final right shoulder triangle usually of equal size and shape as the first. When this forms, it is assumed the stock/index will then breakdown to the amount of at least what the measurement of how large the head was. Also note that the breakdown occurs after three touches of the support line.
In the market meltdown of 2007-2008 the top of the market was characterized by a series of this exact head and shoulders setup. (see fig 3 below)
In other words, experts and news aside, the ‘chaotic’ breakdown of 2008 was in fact a drop that was highly predictable and in fact where it dropped to and where it reversed from were levels that were almost exactly what the pattern of the head and shoulders had predicted. This illustrates how vital it is to understand the role such a powerful pattern plays in predicting big money moves.
An example of how this pattern can be applied in current markets we can use it to observe the way the S&P 500 has been currently moving in recent times. As you can see in the chart it appears to be forming the beginning of yet another head and shoulders pattern and is perfectly timed with the other factors we will discuss later. If this were to continue, we have projected out what this would look like over the months to come. This would mean a likely 1600 target level on the S&P 500 at some time during the first or second quarter of 2016. These are rough measurements used but a prediction of what a head and shoulders would look like if this pattern were to confirm by breaking down from the area displayed in the chart.
A break much above the 2000 level would indicate a failed head and shoulders and that smart money is going a different direction. This would indicate us to go long and could see a test of the 2,100 level or a retest of the upward channel at 2,250 as it extends upwards to the right.
Understanding the Patterns of the chart is one of the most vital aspects of trading in being able to determine where the money is moving and also tells us the key levels at which the pattern dictates us to buy and sell with highest probabilities.