The Best Head and Shoulders Set-Up I’ve Seen in a Long Time

The Flat-Topped Red Megaphone Provides a Perfect Set-Up for a Simple H&S Right Shoulder

The Flat-Topped Red Megaphone Provides a Perfect Set-Up for a Simple H&S Right Shoulder (Green Scenario)

ES ran into heavy late-day selling from the day’s VWAP on the day’s heaviest volume, returning the price to a perfect place for a head and shoulders neckline (navy blue on chart).

That left a particularly nice head and shoulders set-up on the 2-minute chart.

ES spent most of the day forming a flat-topped falling-bottom megaphone (red on chart).  ES would usually put in a fast wave up to the formation top for at least a fake breakout.  A fake breakout that quickly reentered the formation would target taking out the formation low, which would mean a breakout through the head and shoulders neckline (green scenario).

A genuine breakout through the top of the red flat-topped megaphone would target the navy blue megaphone top for one last new high before a likely breakout downwards from a megaphone top (purple scenario).

A breakout from either formation would target roughly ES 2050, where it would run into the bottom of its orange rising megaphone off the September 29 low as well as the neckline of a larger H&S.

Nested Head and Shoulders Tops on ES 60-Minute Chart

Nested Head and Shoulders Tops on ES 60-Minute Chart

The price would usually bounce off the bottom of the orange rising megaphone but not put in a new high.  That would make for the right shoulder of the larger H&S.  A breakout through the bottom of the orange rising megaphone would target at least the level of the lowest touch on the formation bottom.

If this trade is going to go wrong, the most likely place for it to go wrong would be immediately after the breakout through the orange rising megaphone bottom.  If the price stops moving down and starts swinging back and forth to form a megaphone there, I’ll be posting a set-up to get long again.

The Price Action Near the Purple Megaphone Bottom will Determine if the Next Target is 1500 or a New All-Time High

This is a trading set-up where the price action near the bottom of the purple megaphone is especially important for the longer-term.  A small difference in the price action will determine whether the next target is 1500 or a new all-time high.

Essentially, if bulls jump in to buy the retest of the August 24 low before the price takes out the low, the longer-term scenario will be bearish.  If the price instead just melts down to the purple megaphone bottom with everyone chasing, the next target will be a new all-time high.

The minimum target for the move down from the purple megaphone top is a breakout through the megaphone bottom roughly equal in size to the breakout ES has put through the top.  But if ES can retrace to the purple megaphone VWAP at 1950 from a place in between the August 24 low and the September 29 low, it will be legal for a breakout downwards from the purple megaphone with a target as low as the 1500 area (green scenario).

However, if ES just melts down to the purple megaphone bottom, taking out the August 24 low before a retrace to 1950, the target from the purple megaphone bottom will be a new all-time high at the purple megaphone top (purple scenario).

SPY Double Bottom at 186.82

SPY Double Bottom at 186.82 Would Usually Mean a Bounce to 195 Before Reaching the Purple Megaphone Bottom

SPY Double Bottom at 186.82 Would Usually Mean a Bounce to 195 Before Reaching the Purple Megaphone Bottom

Unlike ES, SPY has a double bottom at its August 25 and September 29 lows.

That puts a flat-bottomed rising-top megaphone on the chart (red), which means a bounce off 186.82 or a little below is likely to retrace to 195 before continuing to the purple megaphone bottom.

The bounce has different implications depending on how exactly it plays out.  It could set up a breakout from the purple megaphone to the 170 area (purple scenario).  Or the price could megaphone back to 195 (blue scenario) or form an inverse H&S with a neckline there (green scenario), virtually guaranteeing another trip to the purple megaphone top.

Still In Blow-Off Top (Updated)

ES is Still in Its Red Rising Wedge After BOJ Said No Candy for You

ES is Still in Its Red Rising Wedge After BOJ Said No Candy for You

ES is still in its red rising wedge after the BOJ, like the Fed, declined to provide additional fuel for the market’s blow-off top. Bulls continue to buy smaller and smaller dips, the defining characteristic of a blow-off top.

ES is putting in the blow-off top on a classic 5th-wave melt-up within a large topping megaphone (purple on chart below).

ES is Setting Up a Move through the Purple Megaphone Bottom

ES is Setting Up a Move through the Purple Megaphone Bottom

Megaphone 5th-wave melt-ups usually complete with a head and shoulders pattern at or across the megaphone top.  Then the price returns to the megaphone bottom for a breakout of roughly comparable size.

ES is now so close to its all-time high that it’s possible it will squiggle its way up to a new high in the process of putting in a top.  There’s a strong set-up on the chart that suggests it will head to the megaphone bottom before reaching a new all-time high, but even if ES does put in a new all-time high, it won’t kill the set-up for a fast move to the megaphone bottom.

What happens after that depends on whether ES actually puts in a new high or not before heading down.  I’ll update the longer-term scenarios over the weekend.

A breakout through the bottom of the orange rising megaphone would be a set-up to short.  If ES puts in one more higher high within the red rising wedge, you could short on the breakout from that, but as I type this, it is looking like ES will break out of the formation here and complete the topping process another way.

The next dip may give us a set-up to short higher up.

Update:  ES is putting in a second fake breakout from the red rising wedge at the open.  That’s likely to be followed by one more higher high.

One More Fake Breakout and the Next Would Likely Be Real

After Another Fake Breakout from the Red Rising Wedge, the Third Breakout would be a Set-Up to Short

After Another Fake Breakout from the Red Rising Wedge, the Third Breakout would be a Set-Up to Short

The algos have recently made a specialty out of flat-topped and flat-bottomed triangles and megaphones. They put in a little flat-topped triangle on ES today.

The play was the same as all the other recent examples–to set up a flat-topped triangle, then pop the price through the top to eat the stops while selling into the breakout buying. The price then reenters the formation and takes out the formation low. Then they swing the price up to break it out past the earlier pop high.

An overnight swing to take out the triangle low would put in a second fake breakout through the bottom of the red rising wedge on the ES chart. Rising wedges usually put in two fake breakouts before the real one. The third would be a set-up to short.

Here it is on the 60-minute chart for Mac.

Set-Ups on 60 Minute Chart

Set-Ups on 60 Minute Chart

If the short set-up is going to fail, which is unlikely, it will fail at the bottom of the orange rising megaphone. If you see a megaphone form there, prepare to get long back to the all-time high to see if ES can put a major melt-up set-up on the chart.