Traders bid up the to a new all-time high after the announcement that Jerome Powell will be at the helm of the US Federal Reserve for a second term. Markets see continuity as a sign of stability.
However, very quickly, traders changed their minds. After the knee-jerk buy orders, they remembered that they consider Powell to be more hawkish than Lael Brainard, the alternative option and now the nominated vice-chair. So traders sold off all-time highs for the Dow, paring the day’s gains. We posit that this extreme indecision may be a prelude to a top.
Let’s look at the chart.
Dow Jones Daily
On Tuesday, the Dow rose 0.55% after wiping out most of Monday’s gains. Investors sold off when they changed their opinion and decided that Powell was not good for the stock market.
Was the original advance justifiable?
Note how the previous two session highs found resistance by the October highs, which happened to form the left shoulder of a potential H&S top.
Moreover, the pattern’s head forms a smaller H&S pattern. Yesterday’s rebound formed a return move towards its neckline. The smaller H&S top’s target is below the more oversized top’s neckline, increasing the odds that the more extensive reversal formation will complete with a downside breakout below 35,600.
Conservative traders should wait for the downside penetration of at least 3% and one that will last for at least three days to avoid a bear trap. Then, they’d wait for a corrective rally that would test the pattern’s integrity.
Moderate traders would also wait for the pattern’s completion with a downside breakout, but will be content with a 2%, 2-day filter to avoid a whipsaw. They, too, would wait for a return move for a better entry, if not trend confirmation.
Aggressive traders may be short now, relying on the smaller H&S’s target, provided they accept the higher risk that comes with going for higher rewards when moving before the rest of the market. Money management is critical.
Here is an example that showcases the basic points of a trading plan:
Trade Sample – Aggressive Short Position
- Entry: 35,800
- Stop-Loss: 36,000
- Risk: 200 points
- Target: 35,000
- Reward: 800 points
- Risk:Reward Ratio: 1:4
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