The bulls continue to dominate, with the S&P 500 hitting a record high of 2,152.14, the Dow Jones Industrial Average (DJIA) setting a new closing high of 18,347.67, and the NASDAQ closing at 5,022.82 – it’s highest since late December 2015.
But three upcoming events this week could send the markets up or down – dramatically.
So I’m going to show you a unique way to spot a potential shift in the current bullish trend… using shapes.
And by the time you’re done reading, you’ll know each one of the three upcoming catalysts and how to pinpoint trading opportunities – no matter which way the markets move.
Using Consolidation Patterns to Spot Changing Trends in the Stock Market
In light of the recent, record-setting highs, you may be feeling pretty encouraged if you were long these markets and pocketed a nice chunk of cash.
But if you thought the markets were overvalued and due for a short-term sell-off, you may not have taken a long position… and may be feeling like you missed out on thousands of dollars in profits.
Now one thing traders (most often, novice traders) do to compensate in a situation like this is chase prices higher when stocks are breaking out to new highs or out of a trading range. And what ends up happening is they spend more money than they wanted – or should – for one, single trade.
This is not what you want to do when you feel like you’ve missed out on some nice gains. Instead, you just have to be patient and let go of any frustration you may have so that you can be prepared for the next major market move.
And as I said…
We’ve got three big events to watch this week that could change the direction of the stock market – for better or for worse…
- Bank earnings: Tomorrow (July 14), JP Morgan Chase & Co. (NYSE: JPM) releasing earnings, followed by Citibank (NYSE: C), and Wells Fargo & Company (NYSE: WFC) on Friday. And the options market anticipates over a 3% move higher or lower after the results are in…
- Jobless claims: The U.S. jobless claims report also gets released tomorrow. Higher claims could signal slowing job growth while lower claims could signal faster growth – which could push the markets in either direction.
- Consumer comfort: On Friday, the Bloomberg Consumer Comfort Index Report comes out and will give us an idea of how consumers feel right now about the economy, personal finances, and the markets. And if it shows a pullback in consumer confidence, we could see a change in this upward trend.
That’s why we’re going to look at a new patterns you can use to track shifting trends in the markets, called a “consolidation pattern.”
Consolidation patterns form when there is no clear directional winner between buyers and sellers. A price will tend to oscillate between a support and a resistance area for a period of time until one camp, the buyers or the sellers, starts to dominate the other.
When breakouts or breakdowns occur, they usually do so out of a period of consolidation (a consolidation pattern). You can identify these periods of consolidation on a stock chart by the shape it makes on a chart. The most common shape that signifies a consolidation period for a particular stock is a rectangle.
Other shapes can be drawn in on a chart after the breakout or breakdown, giving an indication of whether the breakout or breakdown will have conviction for a future price move in the direction of the break. But we’ll get into those later this week…
Right now, take a look at the two rectangle patterns I’ve shown you below:
Look at the period of time in which the consolidation is happening. The time during which the stock (PM) is trading between both a support and a resistance area gives astute, options traders like us the opportunity to trade this pattern itself.
You can wait for the stock to breakout or breakdown, but in the meantime the option trader can capitalize each time the stock trades from one side of the range to the other.
This type of pattern drives investor’s crazy! For example, say they bought the stock at the beginning of the range on support. Fast forward three months or so, and the stock is at the support area – leaving investors with zero appreciation. But us options traders may have placed three different moneymaking trades in that same time frame, buying call options on support and selling them at resistance.
Here’s another example…
Let’s say the stock breaks out above resistance (look for it to do so on decent or above average volume), just as it did mid-Feb. above $90 and ran up to $102. If you missed getting the stock at $90 or sooner, you may have thought that picking it up around $92 or $93 was too expensive because it already broke out. You may have also thought that if people take profits or deem it overvalued it will probably come down in price and they will be stuck in a loss position.
But what you need to realize is that prices on a breakout can (and often times do) come down and test that breakout area before climbing higher. This breakout area is resistance, which we took a close look at when talking about “old resistance becoming new support” (ORNS).
When the price breaks out with volume backing it up, look for the price of the stock to come down a bit due to some profit taking. This retracement in price should be short-lived and done on less volume than was shown on the breakout.
The stock comes down to the old resistance price of around $90 – and those who didn’t get it the first time AND wanted to get more at the initial price start buying again. Lo and behold… you’ve got a stock that makes a run higher.
It is that period of time where the stock is retracing a bit after the breakout that the stock is establishing that ORNS situation.
Now if you look closely at what the chart pattern formed after the breakout of $90, you will see a triangular pattern instead of rectangular one. But again, we’re going to talk about that next time.
At the moment, though…
The S&P 500 or SPX is trading at all-time highs and has broken out above a resistance area. And for the last three days, including today, it’s continued higher – and could very well go higher.
As we discussed previously, the SPX broke down through an ascending support area down to the price area of 2000. And if you look back, you can argue that it’s a support area for the SPX as well.
Here’s one more example of another rectangle pattern where the support area is a little higher than 2000:
It broke down through that support before hitting 2000. Then, it bounced back up into that range and has proceeded higher to the prices it’s at right now. On that breakdown, SPX’s price had the chance of coming back to the support area and consolidate before proceeding lower.
But it didn’t….
Look for Bullish Trading Opportunities when the Pattern Continues
Now many traders observe that if the stock, ETF, or index doesn’t hold or close above the area it broke from for three days, it may be a false break. Some traders I know are a bit more aggressive and willing to take a trade if it holds for only one day and some even just need the price to trade above the break point, not needing it to close above or below. But I think that’s too risky and that three-day hold as the way to go.
And that makes me inclined to stay long in my trades and see what the SPX and the markets do from here.
Although we’ve got upcoming earnings, jobless claims, and consumer comfort reports, we just don’t know exactly how these events will affect the markets. As of this moment, I wouldn’t be surprised to see prices move higher on a sentiment of “strength begets more strength.” This leaves the prospect of people chasing after these prices for fear of missing out pretty open. Just remember… you should never chase prices.
There is also the camp of folks who may feel more confident at these higher prices and will continue to buy. But there may also be the contrarian view that far too many financial and news pundits share in that these prices can’t be sustained. So long as there’s fear and skepticism, the markets could move at the any given news or event.
And that’s exactly why I wanted to show you how to be visually be aware of support and resistance points and their corresponding patterns. That way, you can be more confident in your buying-to-open and selling-to-close trading decisions.
Personally… I’ll be ready if prices dribble back to 2100-2130 or so (the solid horizontal blue line). I will also consider a retrace to 2100 (the green dash line on the chart below) where old resistance (descending resistance line), could possibly becoming a new support area for the S&P 500 – especially after we see what unfolds this week.
So check the volume on the retracement (if it happens) and see if it did so on weaker volume. Once you see a possible continuation pattern, like that triangle, zig-zig, or flat pattern I referenced above and get the sense that markets should hold this “old resistance area as new support,” you can count on looking for bullish opportunities.
Here’s Your Trading Lesson Summary:As you’ve seen, the markets have been on a bullish run these past few weeks. But we’ve got three big events to watch this week that could change the direction of the stock market – for better or for worse. And a consolidation pattern will tell you if the bulls will hold the lead – or give way to the bears…
Until next time…
Stay safe, and good trading,