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Head-and-Shoulders: Reversal Pattern Predicts How Far a Stock Could Fall

The head-and-shoulders pattern is sometimes seen on price charts ahead of a downside reversal.

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The head-and-shoulders pattern is sometimes seen on price charts ahead of a downside reversal. It occurs after an uptrend and consists of three peaks in price, with the center peak being higher than the other two. The two “side” peaks should be about equal in height.

The three peaks give the pattern its name, with the center being the head and the right and left being the shoulders. Connecting the bottom of the peaks is what is called the neckline, and a break of this support level is the signal that the uptrend is reversing.

Chart patterns have been documented in books and articles since the 1930s, and the head-and-shoulders is among the most famous. Several studies since the 1990s have demonstrated that the pattern works to identify market turning points. In one of the first studies, economists at the Federal Reserve said it was “not just a flaky pattern.” Since then, a number of respected academics have reached similar conclusions and agree that traders can obtain profits by using the pattern.

How Traders Use It

A head-and-shoulders pattern can be used to time sells in the market. Traders have found that the pattern can work in any market, and many traders look for the pattern in stocks, futures and foreign exchange markets.

The daily chart of the British pound shown below is an example of a tradable head-and-shoulders pattern that formed in late 2009. This example includes a throwback, price behavior that is commonly seen.

After breaking down through the neckline, prices often trade back up to that level, and the move back toward the neckline is called a throwback. Throwbacks also illustrate the idea that support (i.e., the neckline), once broken, becomes resistance.

In addition to providing trade timing signals, price objectives can also be obtained from the head-and-shoulders pattern. The measuring rule is to expect a decline equal in size to the range from the neckline to the high reached at the top of the head.

In the chart above, the decline failed to reach the objective before the throwback. Prices rallied back to the level of the neckline before falling lower and eventually reaching the downside objective.

Why It Matters To Traders

In addition to providing trade timing signals, the head-and-shoulders pattern offers price targets, and there are few tools that traders can use to project how far a price move should go. This makes the pattern very useful for assessing how close we might be to a bottom. Once the price objective has been reached, traders may take long positions with more confidence.

Chart patterns like the head-and-shoulders can be used as a trading strategy, or they can be combined with other indicators to develop a more detailed view of the markets. Either way, this pattern has allowed many traders to profit over the years.

Image by InvestmentZen | www.investmentzen.com

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Goldman Sachs CEO Thinks Markets Are Too High

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Original Link | Motley Fool

Analysts and commentators are often derided for saying that stocks are overpriced and due for a correction. Behavioral economics, the fad at the moment, holds that making predictions is like throwing darts at a dartboard with a blindfold on.

But what happens when a growing chorus of the best investors in the world all start to say exactly that? Should these people also be treated like Greek mythology’s Cassandra, who could see the future but couldn’t persuade others about her predictions?

The latest example is the chairman and CEO of Goldman Sachs (NYSE:GS), Lloyd Blankfein. At an industry conference this week, Blankfein expressed concern about the current state of the markets, saying that the situation “unnerves” him.

“Things have been going up for too long,” he said. “When yields on corporate bonds are lower than dividends on stocks? That unnerves me.”

The head of Goldman Sachs, which has been among the most omniscient of trading firms on Wall Street in recent history, adds his name to a growing list of other high-profile financiers that have publicly expressed concern.

Here’s what Howard Marks, co-chairman of Oaktree Capital Group (NYSE:OAK), wrote in a memo to clients in July:

[I]t’s essential to take note when sentiment (and thus market behavior) crosses into too-bullish territory, even though we know rising trends may well roll on for some time, and thus that such warnings are often premature. I think it’s better to turn cautious too soon (and thus perhaps underperform for a while) rather than too late, after the downslide has begun, making it hard to trim risk, achieve exits, and cut losses.

Since I’m convinced “they” are at it again — engaging in willing risk-taking, funding risky deals, and creating risky market conditions — it’s time for yet another cautionary memo. Too soon? I hope so; we’d rather make money for our clients in the next year or two than see the kind of bust that gives rise to bargains. (We all want there to be bargains, but no one’s eager to endure the price declines that create them.) Since we never know when risky behavior will bring on a market correction, I’m going to issue a warning today rather than wait until one is upon us.

Here’s Jeffrey Gundlach, co-founder and CEO of DoubleLine Capital, a fund with $110 billion in assets under management:

If you’re waiting for the catalyst to show itself, you’re going to be selling at a lower price. This is not the time period where you say, “I can buy anything and not worry about the risk of it.” The time to do that was 18 months ago.

Here’s Warren Buffett, the chairman and CEO of Berkshire Hathaway (NYSE:BRK-A)(NYSE:BRK-B), intimating the same thing in a letter he penned earlier this year to the shareholders of Berkshire Hathaway:

Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons. And that we will do.

And here’s Ray Dailo, the co-founder and chief investment officer of the world’s largest hedge fund, Bridgewater Associates, writing recently in a LinkedIn post:

When it comes to assessing political matters (especially global geopolitics like the North Korea matter), we are very humble. We know that we don’t have a unique insight that we’d choose to bet on. Most importantly, we aim to stay liquid, stay diversified, and not be overly exposed to any particular economic outcomes. We like to hedge our bets, though we are never completely hedged. We can also say that if the above things go badly, it would seem that gold (more than other safe haven assets like the dollar, yen, and Treasuries) would benefit, so if you don’t have 5%-10% of your assets in gold as a hedge, we’d suggest that you relook at this. Don’t let traditional biases, rather than an excellent analysis, stand in the way of you doing this (and if you do have an excellent analysis of why you shouldn’t have such an allocation to gold, we’d appreciate you sharing it with us).

In short, one can be as dogmatic as one likes about predictions, but when investors and financiers like these start expressing concern, it’s probably not such a bad thing to listen.

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4 Reasons Why “Gold Has Entered A New Bull Market”

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– 4 reasons why “gold has entered a new bull market” – Schroders
– Market complacency is key to gold bull market say Schroders
– Investors are currently pricing in the most benign risk environment in history as seen in the VIX
– History shows gold has the potential to perform very well in periods of stock market weakness (see chart)
– You should buy insurance when insurers don’t believe that the “risk event” will happen
– Very high Chinese gold demand, negative global interest rates and a weak dollar should push gold higher

This week gold broke through the key resistance of $1,300. For some time market commentators have been signalling this level as the point of entry for a new bull market.

Often price can be distracting when it comes to trying to figure out what is going on. Two Schroders fund managers called the new bull market in gold about a week before the price broke through the key level.

Gold has entered into a new bull market. As we have discussed previously, there are four main reasons for our stance:

  1. Global interest rates need to stay negative
  2. Broad equity valuations are extremely high and complacency stalks financial markets
  3. The dollar might be entering a bear market
  4. Chinese demand for gold has the potential to surge (indeed, investment demand in China for bar and coin already increased over 30% in the first quarter of 2017, according to the World Gold Council)

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Alphabet Is Getting Squeezed, but a Breakout Is Coming: Chart

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Alphabet (GOOGL) shares have successfully retested a nearly four-month support line and are prepared to make a volatile move higher. This is just one of a number of technology stocks that have recently retested support lines, and have the potential to return to previous pattern resistance levels or to new highs.

Alphabet should be a leading indicator for the space. It is positioned on a well-tested support level and undergoing a volatility squeeze. The level of buying interest this move attracts should be a gauge on the general sector.

There are several ways to identify a potential volatility squeeze in a stock. One indication is when the upper and lower Bollinger bands move inside the Keltner channel boundaries. Bollinger bands are measures of standard deviation around a moving average. Keltner Channels are a measure of standard deviation using average true range.

It is unusual for the Bollinger Bands to contract to a point where they enter the Keltner channel and this reflects a level of extremely low volatility. Periods of low volatility are often resolved by periods of high volatility, and in the case of Alphabet, the resolution should be higher.

Google is a holding in Jim Cramer’s Action Alerts PLUS Charitable Trust Portfolio.Want to be alerted before Cramer buys or sells GOOGL? Learn more now.

Moving average convergence/divergence has made a bullish crossover and the stochastic oscillator has crossed above its center line. These indicators reflect positive short-term price momentum and potential trend direction. The stock has broken above short-term resistance in the $945 area, and is retesting its upper Bollinger band.

It appears the breakout is underway and the first upside price objective is to fill the July downside gap by returning to the resistance level of a large horizontal channel.

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