Broadening Pattern

Dow Jones Industrial Average and S&P 500 are forming Broadening Pattern on weekly timeframes since January 2018. A broadening pattern is an inverse triangle bounded by two diverging trend line – one moving up and one moving down.Edwards and Magee wrote in their seminal book, Technical Analysis of Stock Trends:

If the Symmetrical Triangle presents a picture of “doubt” awaiting clarification, and the Rectangle a picture of controlled “conflict”, the Broadening Formation may be said to suggest a market lacking intelligent sponsorship and out of control – a situation, usually, in which the “public” is excitedly committed and which is being hipped around by wild rumors.

They continue and comment, “Nevertheless, the very fact that chart pictures of this type make their appearance, as a rule only at the end or in the final phases of a long Bull Market lends credence to our characterization of them.” Finally, they conclude that these patterns are definitely Bearish in nature.

In Broadening formation the price touches the lines bordering it five times. S&P 500 has touched these lines four times since January 2018 (see Figure 1) whereas Dow Jones Industrial Average has touched them five times (see Figure 2) breaching once to the downside.

For the past few years the market has been wrecked by a number of sudden and unexpected policy announcement, news and events. The Q4 2017 was the period when the tax cut legislation was debated and then passed. Following that US waged a trade war with China and many other countries. In Europe, the Brexit saga was going on. Since the beginning of 2020 world is facing Coronavirus pandemic and Saudi-Russia crude-oil war.

Whatever the reason, the Broadening patterns are telling us that there is high likelihood that the bull market since 2009 may have ended.

Bouncing From Fibonacci Retracement Level

On monthly timeframes, both indices are rising since 2009 within a linear regression of 120-months and 0.5 standard deviation. Over this period the lower bound had been breached only three times and the upper bound twice. Only recently did the indices closed below the lower bound for the first time.

Since January 2018, the indices have been rising but the 9-month RSI is forming Bearish Divergence. The last divergence was in January 2020 when the indices made new highs but the RSI did not. The decline from all time highs has taken both indices to 38.2% Fibonacci Retracement level of the rally from the lows or 2009 March.

The price is also near significant support levels. The low of S&P 500 in March 2020 was 2191.86, which is just below the December 2018 low at 2346.58 and above the upper bound, at 2134.72, of a horizontal channel that took many months to form and was broken to the upside in July 2016 (see Figure 3).

Dow Jones Industrial Average dropped  much below its December 2018 low but also came closer to the upper bound of its horizontal channel that was formed between 2015 and 2016 (see Figure 4).

These levels show that both of these indices, and the market by inference, have probably declined far enough for this move and are ripe for a bounce, which is underway and may go further up than the current levels.

Resistance Zone Ahead

During the sudden decline of February and March 2020, DJIA and S&P 500 significantly gapped down few times, which formed significant resistance levels for the bounce up. The indices have filled some of these recent gaps. The next significant one is the down gap formed on March 9. This level is also near the 61.8% Fibonacci Retracement of the decline from all time highs.

Also, this is near a congestion area that occurred in August-October 2019, March-June 2019, August-October 2018 and January-March-2018. Confluence of these levels make significant resistance areas. For S&P 500 this is between 2850.00 and 2950 (see Figure 5) and for Dow Jones Industrial Average this is near 24700 and 25700 (see Figure 6).

The range for this resistance zone is large but that is a measure of the volatility, which usually gets bigger during the early stages of bear markets.

Bull-to-Bear-to-Bull Transition, Pandemic and Economy

The first quarter of 2020 saw a sharp decline of more than 20% from all time high. This is a classic signal of bear market. The market also bounced up sharply and rose more than 20% from its lows, which is a classic sign of bull market. However, these are not very clear-cut signs. Let’s take a deeper look.

Prior to the Q1 decline, the U.S indices were flashing signs of topping formation including Bearish Divergence between price and oscillators. There were many Bearish Divergences between RSI and price on monthly charts since January 2018 for both S&P 500 and Dow Jones Industrial Average. On weekly timeframes, both of these indices saw Bearish Divergence in early February 2020. They were ripe to fall over following any significant negative catalyst.

Coronavirus pandemic was such a catalyst. It brought the global economy to a sudden stop. So naturally, the markets fell but the decline was deeper and sharper than any previous economic shocks. The fiscal and monetary response by authorities to support the economy has been aggressive and huge, which, as expected, led to large stock market’s rebound. However, there are many things that are unknown at the moment and they will greatly influence the markets.

These unknowns include when the Coronavirus peak will occur, if and when a vaccine will become available and whether there will be a second wave of it. What is also not known is the extent of damage to the economy. Nothing like this had happened earlier so the existing economic models are not capable of discerning the extent of economic loss.

Next few months economic reports will shed more light on the economic impairment and then only can the market find out whether the actions taken by authorities will be enough or not. So it remains to be seen whether the current bounce is going to last and convert into a bull market.

Historically, market tests the lower levels at least once before it restarts the uptrend. Chances of that happening this time too are still high.