S&P 500 Hits 1,550...What's Next?

03/15/2013 9:00 am EST

Focus: STRATEGIES

C. Douglas Davenport

Co-Founder, All-Weather Investor Trading Service

Doug Davenport of All-Weather Investor got it right—the S&P 500 smashed through 1,550. Here he discusses what to expect next.

Below is a chart of the S&P 500 from August 2011 to today.

Please note the two grey shaded areas on the chart and the two turquoise boxes inside the larger gray boxes. This is a pattern I have noticed, since it is nearly the same as last spring. It is called a “Fractal,” which is a mathematical term for “similar patterns in time.”

So what are we looking at? 1,550 could be the target that is reached soon. [Editor’s note: The S&P 500 Index closed over 1,550 on March 8.]

chart
Click to Enlarge

Back last year, the market was strong in the first quarter. It pulled back in the middle of March from its high. Then it rallied again quickly and reached another high of 1,422.38.

From that “head” in a head and shoulder pattern (middle red line), it pulled back in April and then rallied to a lower high around May 1 to form a right shoulder in the pattern (red line to the right below the middle red line that is the head).

Now the “head and shoulders” pattern is complete—which is a bearish technical indicator. So what happened then?

A decline in May, all the way down to 1,266.74 by June 1—about a 10.5% drop from the high. Remember the old saying, “sell in May and go away?”

What we have now is very similar pattern to last year. We saw a new high form in February, a pullback in late February to around 1,485, and now a push to a new high. The new high in February would be the left shoulder in the head and shoulder pattern, and the new high, when it forms, will be the “head.”

I am expecting that the market will pull back (it can’t go up everyday) and form a low that will be higher than the last low near 1,485, then push back up one more time to a lower high (than what the head will form any day).

With that, we will have the right shoulder to complete the pattern like last year. The markets do repeat patterns that we have seen formed before.

Now I am not certain that this will happen, but I will not be surprised at all to see this occur. I wanted to bring this to your attention.

And technical analysis tells us that the best time to short the SPX, or any security, is when the right shoulder of a head and shoulders pattern has formed and the SPX begins to rollover right after.

That is what I did last year in May—I sold the long position and went short the $SPX.

Read more about All-Weather Investor here...

Related Articles:

Inside the Mind of an E-mini Trader

S&P Hits 1,500. Where to Next?

When Should You Stay Out of the Market?

Related Articles on STRATEGIES