Equity indexes may be preparing for a major breakout/breakdown following the completion of a Megaphone Patterns across all three stock indexes, writes Suri Duddella.

The month of September is known historically as the worst performing month for U.S. stocks. Since 1950 the Dow Jones Industrial Average (DJIA) has returned -1.0% in September and the S&P 500 has returned -0.5%. Since its inception in 1971, Nasdaq returned around -0.5% in September. The September effect somewhat dissipated over the past 25 years, but the markets have not returned to positive returns in September. The September effect is not limited to U.S. markets but experienced by worldwide markets. 

Many investors avoid investing in September as this statistical anomaly is consistent with its poor performance. During September investors are anxious about the third-quarter earnings, mutual fund tax-loss selling and end of summer sales and tend to avoid investing in stocks.

Current U.S. markets appear to be entering a corrective phase as near-complete Megaphone Patterns are forming in all three major stock indexes. 

The Dow Jones Index, S&P 500 and Nasdaq Composite have been trading in a Megaphone Pattern since 2018 and it has formed its last (5th) node in July 2019 to complete the pattern structure. 

Megaphone patterns

Megaphone Patterns, also called Inverted Symmetric Triangles develops after a strong up or downtrend in the stock price. Megaphone Pattern formations have five sharp swings. Each swing is larger than the previous swing, which gives the formation and its Megaphone appearance. The key swing points in the Megaphone Pattern are structured with lower low troughs and higher peaks and are connected by two diverging trendlines. The key swings of the pattern are the first and the fifth swings, which show the reversal of major direction prior to the formation of the pattern. Another unique characteristic of Megaphone Top/Bottom Patterns is that each swing's increasing volatility triggers the reversals of upside and downside swings.

Megaphone patterns present two trading opportunities: Trading the breakout as a Megaphone Continuous Pattern and trading the reversal as a Megaphone Reversal Pattern. Trades are placed after price reverses from the fifth swing pivot level.

Dow Jones Industrials Daily Chart patterns

The charts below show Megaphone Patterns in Dow Jones Industrials daily charts. The larger Megaphone Pattern formed from 2018 is completed in July 2019 with its fifth node at 27,398 and its Megaphone midpoint at 24,980. The smaller Megaphone Pattern started in March 2019 also completed in July 2019 with its midpoint at 25,700. Currently, the Dow Jones is supported by 200-day simple moving average (SMA) at 25,622, and a breach of SMA level could trigger a sell-off towards the lower end of 24,500.

Megaphone Patterns

The fourth chart shows a smaller Rectangle Channel Pattern formation in the Dow from August 2019 with its upper boundary at 26,388 and lower boundary at 25,339. Rectangle Channel Patterns are formed by price action between two key trendlines bound by multiple equal (near) highs and lows. The price breakout can occur in any direction from the pattern, but the general belief is price may breakout in the same direction as the prior trend before the pattern formation. The volume inside the pattern is non-decisive, but volume tends to increase during the breakouts.

Find more of Suri’s work at surinotes.com.