Exposing Ideas to the Envelope of Serendipity

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Wednesday, December 15, 2010

Cups, Handles, and Food For Thought

While perhaps not an obvious interpretation, it seems increasingly worthwhile to at least consider the longer-term picture on the $SPX as a possible large cup & handle pattern that recently broke out. A cup with handle pattern, as originally identified by Bill O'Neil, is a continuation pattern that forms as a consolidation phase following a well-established preceding uptrend. The "cup" retraces a portion of the ascent, ideally not much more than one third. The "handle" forms as a pull-back or pause in the price advance after completing the right side of the cup, usually angling slightly downward. An initial buy signal is generated (for my purposes) when the price moves above the descending trendline that runs along the top of the handle. The second, or confirmation buy signal generates on a move above the high point of the right-side of the cup. These are considered among the most bullish of patterns, most often leading to considerable additional upside.

While the current $SPX pattern does exhibit most of the general characteristic attributes, it does have a couple of potential flaws -- one, in my experience it is generally preferable for activity within the cup to be somewhat quiet, which definitely was not the case here, although that in and of itself is not a disqualifier. And two, the handle phase in this case is somewhat shorter than I like to see, but there is no required time interval.

So if the current pattern does indeed turn out to be a cup with handle with the characteristic outcome, how might that play out, particularly in light of widespread expectations for a near-term correction that's more significant than what we've seen thus far? There are at least a couple of possible scenarios that could unfold while keeping the pattern intact: we could see a pull-back to support at the November highs and the breakout point of the pattern sooner rather than later followed by a resumption of the uptrend once that is complete, or we could see another push higher near-term, perhaps to test some key overhead resistance levels in $NDX and $RUT before seeing a significant correction take hold perhaps in early 2011. Failure of the pattern would occur with a decisive move back below the breakout point (a move on volume of more than a few points, with follow-through to confirm). Food for thought in any case (or perhaps given the pattern in question, 'coffee for consideration').

Trade well.

-- Brinkley
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