QQQQ Tests its Lower Channel Line

01/29/2010 11:14 am EST

Focus: STRATEGIES

In mid January, the PowerShares QQQ Trust (QQQQ) daily chart broke down from its accelerated trend line that began in November (see chart). The penetration of the trend line caused prices to fall all the way back to the lower trend line of a multi-month rising price channel, which began in August of 2009.

Traders were forewarned of the reversal by the bearish divergence that appeared on the moving average convergence/divergence (MACD) histogram (12, 26, 9) in late December. As the histogram’s vertical bars ticked lower, the QQQQ drifted sideways and completed a bearish rising wedge pattern, which offered further evidence of a potential reversal. The bearish price pattern was trading just above the 20-day moving average (MA). As prices did the side step, QQQQ moved into its accelerated trend line and 20-day moving average (MA) simultaneously for a test.

On January 21, with one big swoop, prices broke the accelerated trend line, fell below the 20-day MA, and closed below horizontal support. The following session, the QQQQ collapsed even further, dropping below its 50-day MA. Eventually, prices made their way down and came to rest on the lower channel line, which begs the question, are prices going to bounce or break down?

The QQQQ is now at a fork in the road as it tests this crucial level of support. With prices below the 50-day MA, there are now two bearish scenarios in play, and which one plays out all depends on whether prices rally off the lower channel line or not.

First, if prices bounce off the lower channel line, they may be drawn back up to the 20-day MA like a magnet, which is currently hovering near horizontal resistance in the high $45 area. If horizontal resistance holds and the 20-day MA continues to bear down over the Qs, it will complete a lower high. That may quickly result in an avalanche of selling, causing prices to nosedive and penetrate the lower channel line. That would open the door for the Qs drop like a
lead balloon and  test the speculative neckline near $40.

In contrast, the second scenario assumes that the lower channel line breaks immediately, causing the QQQQ to travel down to the mid $40 area to complete a potential head of a very large head and shoulders pattern. The neckline is at the November low, just above the 200-day MA. Once that level is tested, then the bulls can regroup and carry prices higher to form a right shoulder in order to complete the pattern. As the right shoulder carves out, it would produce the lower high that the bears are looking for to confirm a change in trend.

By Ron Walker of TheChartPatternTrader.com

Ron Walker is an active trader and technical analyst. He operates an educational Web site dedicated to the study of technical analysis. His Web site, TheChartPatternTrader.com, offers free market analysis with daily video presentations and written commentaries.

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