Technical analysis is a process of pattern-matching and assessing probabilities of future price action. From time to time we get beautiful, classic chart patterns, and this is one of them: the chart of the Dow Jones Industrial Average (DJIA) has traced out not one but two classic formations: a bearish flag, and a triangle/wedge. (The S&P500 looks very similar.)

In the usual scheme of things, bearish flags resolve to the downside, and triangle/wedges resolve in the direction of the trend, which is currently down. As TA folks say: surprises tend to happen in the direction of the primary trend.

In a wedge/triangle (a formation with many variations such as pennants), price traces out a pattern of higher lows and lower highs, compressing price action into the apex of a triangle as buyers and sellers reach an uncertain equilibrium.

As price gets squeezed into a narrowing band, the likelihood increases that price will break out of the triangle, either up or down, in a major move. While Bulls might discern hope for a breakout to the upside here, the presence of the bear flag lends weight to the bearish expectation of a continuation move in the downtrend.

One feature of chart patterns is their fractal nature: they appear in charts of all durations. Though we usually look for a head-and-shoulders "topping pattern" in longer term charts, this 15-minute (10-day) chart certainly exhibits head-and-shoulders-like characteristics:

Nobody knows what will happen tomorrow or next week, much less next month, but if these patterns are setting up a distinct possibility that the current snapback rally is simply resolving oversold conditions, and that a continuation of the trend (down) will soon reassert itself.

Probabilities are not guarantees, and the past is not a template for the future, it is only a palette of possibilities.


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Readers forum: DailyJava.net.



My new book An Unconventional Guide to Investing in Troubled Times is available in Kindle ebook format. You can read the ebook now on any computer, smart phone, iPad, etc. Click here for more info about Kindle apps and the book.

Order Survival+: Structuring Prosperity for Yourself and the Nation (free bits) (Mobi ebook) (Kindle) or Survival+ The Primer (Kindle) or Weblogs & New Media: Marketing in Crisis (free bits) (Kindle) or from your local bookseller.

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