Long-term bonds: trying to break out?

Let's look at the chart of TLT:

 
TLT broke out of a 6-month channel in August and has been retesting the channel's upper boundary for three weeks. Now, it is trying to break out of a 3-week channel.

In my chart trading mode, I don't make macroeconomic predictions or engage in economic analysis. Instead, I follow the price. Still, it is fun to think about the implications of particular price moves. If stocks struggle while long bonds shoot higher, we might suspect that the economy is slowing and/or investors and traders fear deflation. Then of course there is what the Federal Reserve may do in response to low inflation expectations (QE 4?) and the Fed's effect on stocks, bonds, and commodities.

Or, we can just follow the price.

UPDATE: S&P 500

Let's look at the SPY chart:

For three weeks an ascending triangle has been forming. Today SPY broke above the horizontal upper boundary in a seemingly decisive breakout. But by the end of the day prices reversed and closed at a loss: a classic reversal day.

Now what?

First, the strong reversal was not so surprising. After all, there is strong resistance in the 200 to 203 level.

Second, today's reversal does not preclude another breakout attempt that may take SPY to new all-time highs.

Third, anything is possible. Patterns can morph and change into something else over a matter of days. The ascending triangle? Over the next several days it may become a bearish rising wedge that produces a decisive breakdown. 

All we can do is accept the price action and trade when the reward-to-risk ratio is favorable.

Analysis of U.S. stock indexes

Last month, we discussed possible topping patterns in U.S. stock indexes and individual stocks. Let's see what the charts have done in the two weeks since the start of heightened volatility.

Let's look at the SPY (S&P 500) chart:

We see a dramatic breakdown from a 6-month H&S top. Prices rebounded from the October 2014 low and have been coiling in a pennant pattern for 2 weeks.

Today SPY was decisively turned back at the 198-199 resistance (formerly support) level. This rejection does not mean that the current 2-week coiling pattern will become a bear pennant that continues the decline. There are no "musts" and "shoulds" in trading other than the utmost importance of limiting our risk on every trade. The current coiling pattern can launch a move up and retest the 204 level and even beyond. Again, there are no guarantees in the market. Especially this market, which has been an epic bull run since the March 2009 low. We must be open to all possibilities. And it is possible that the market will break down and ultimately become a harsh bear market but only after SPY races back up to 204 or even a new all-time high.

So we must keep our eyes open and accept the price action as it is. If we are short, then we must have a strict stop level at which we cover our shares - no ifs or buts. The same for longs: we must stick to our stop level where we will sell and cut our losses.

Please remember that there will always be more set-ups to trade. Let the price action tell you the market's intention. Prices are coiling now. That means the market can go up or down. If it breaks down, then we might look for an advantageous entry spot for shorting. If it breaks up, then look for a good spot to go long . Or, don't trade. We are not required to trade. Doing nothing is often the most profitable move.

Stay patient. We need psychological experience in the market, and that comes through living through a complete market cycle. Then we have a chance of accepting what we see rather than what we want to see.

NYSE completes H&S top

Last month we discussed whether the NYSE index was forming a H&S top within a bearish rising wedge. Today's price action suggests that the NYSE index has completed a significant topping pattern:

Other U.S. indexes are at critical support levels. As we discussed yesterday, IWM (Russell 2000) seems to be breaking down from a H&S top.

Remember, we must trade the actual price action rather than our wishes. I lose sight of this truth often. And the warning applies to both bears and bulls. Long-suffering bears may - may - be getting the breakdown that they have been waiting for so long. But this epic bull market has made countless stick saves to continue its run higher. We must trade with discipline and respect our stops. If we are bullish, then we may be proved right again. But we, too, must respect our stops if the market continues to break down. The stock market lost more than half of its value during the 2007 to 2009 financial crisis and 90% of its value during the Great Depression. And yes, these events will happen again for human nature is constant.

Making money is not the traders' priority. There will always be more compelling set-ups. Our priority is surviving and protecting our capital.

Analysis of U.S. stock indexes

The current bull market that started in March 2009 has been epic. Again and again, at key moments, the market bounced from key support levels. Countless Head & Shoulders Top patterns turned into H&S Top Failures that started yet another run higher. Countless sideways trading became continuation patterns that started the next leg higher. The market survived key tests and thrived.

We seem to be at another key test. Let's first look at 6-year weekly chart of SPY (S&P 500):

A historic run where the market has gained more than 200% in 6 years. Next, let's look at a 3-year weekly chart that shows a possible 3-year trendline support:

Next, a daily chart focusing on the past 10 months:

Intriguing possibilities. But, stocks have not broken down so far. And they haven't for 6 years. An epic breakdown is possible, but it is only a possibility. And there are good reasons to think that the market will bounce yet again. SPY is resting and finding support at its 200-day moving average. If the 200-day is pierced, then there is likely to be strong support around the 205 level.

So several things have to happen before a breakdown is confirmed. My approach is to stay patient and let the market point the way. There is no need to try to predict. We cannot. Instead, we should let the market declare its intention. We'll likely find a good entry spot even after the fact.

Let's look at IWM (Russell 2000) for comparison. I find the IWM chart the most interesting among the indexes.

First, a 6-year weekly chart:

IWM is up 265% since the financial crisis low. Will it continue higher or is a reversal near? Let's look at a 10-month daily chart:

Next, let's focus on the past 5 months:

Such a pattern within a pattern is always interesting but never guarantees a set-up will work. In fact, the more intriguing the pattern, the more dangerous. Why? Because we get obsessed with the set-up "working" and producing the wished-for outcome rather than trading the actual price action.

So, for now, we should be aware of the potential set-ups. Then we must have the patience and strength to let the market show us the way.

Ralph Lauren breaking down from a 3-year topping pattern

Let's look at the weekly chart of Ralph Lauren:

From about $30 a share at the financial crisis lows of 2009 to almost $200 a share in mid-2013, Ralph Lauren has mirrored the current historic bull market. Now, however, Ralph Lauren may have topped out and started a significant down trend. The next chart is a daily chart that focuses on the previous 18 months:

We see a 5-month continuation rectangle that could propel the breakdown.

Warning: Ralph Lauren is due to release is next earnings report on August 5, 2015. The market's response to an earnings release is unpredictable. I exit from all or most of my position before an earnings release no matter how promising the pattern. The only exception is if I am sitting on a significant profit. If I were not in this trade yet, I would wait for the dust to settle from the earnings release and then evaluate whether there is an attractive entry opportunity. If no entry spot presents itself, I must remember to let this trade go - because there will always be other opportunities.

H&S top in Huntsman (HUN)

Here is the 6-year weekly chart of HUN:

Next is the 2-year daily chart showing a massive 22-month Head & Shoulders Top:

As always, don't chase. If we wish to short this set-up, we could wait for rallies to the $21 level and set our stop somewhere around $22. Such an entry has a more favorable reward-to-risk ratio than hastily shorting around $19 - but that's just one possibility. We need to determine our risk tolerance and comfort level. It is always best to err on the side of caution.

What if there are no retests of the neckline that give us a more favorable entry spot? Then let this trade go. There will be many more opportunities. Stay patient. 

And, of course, every pattern - no matter how well-defined and textbook, can fail. We must respect our stops and move on when a pattern fails and becomes something else.