Market Summary

Some air came out of the balloon this week as last week's confidence that the Fed would not raise interest rates further and had also engineered a soft landing for the economy dissipated. Falling oil prices also helped lift the markets last week, but that trend reversed this week.

There was less confidence that increases in interest rates are at an end for now following hawkish comments on Tuesday by Chicago Federal Reserve President Michael Moskow who said "The risk of inflation remaining too high is greater than the risk of growth being too low," and "some additional firming of policy may yet be necessary to bring inflation back into the comfort zone within a reasonable period of time". There was some disappointment when Fed Chairman Bernanke failed to provide a countervailing view in a prepared speech on Friday.

Confidence in the 'soft landing' was shaken by two reports showing that the residential property market has cooled almost to freezing point with inventories of used and new homes rising rapidly. Consumer spending, which accounts for 70% of economic activity, was buoyed over the last 4 years by the 'wealth effect' of rising home prices and cash extracted from homes through refinancing. If consumer spending declines then economic activity will drop and so will corporate profits with dire consequences for stock prices.

For the week, the markets consolidated last weeks exceptional gains with a slightly downward move. The DJI slipped 0.86%, the NASDAQ gave up 1.09% and the S&P 500 corrected by 0.55%. However, these slippages came on very light volume. Pullbacks on light volume after strong gains are signs of sanity in the market.

Our market signal remains at exit for the NASDAQ as that market is still 96 points below its 200 day moving average.

The week brought 20 confirmed breakouts, about average for recent weeks. By Friday evening, these had gained an average of 1.57%, comfortably beating the major indexes.

The oil and gas industry's leadership was replaced this week in our technical ranking of industries by the Food and Dairy Products group while the Food and Meat Products group was the most improved in the technical rankings.

Head and Shoulders Bottom Pattern on Beta Test

This week we are pleased to be able to introduce a new chart pattern - the Head and Shoulders Bottom. We are presently only displaying charts of stocks that meet the definition below. We hope to start issuing alerts and reporting on breakouts from this pattern following the Labor Day weekend.

The head and shoulders bottom pattern is recognized as one of the most reliable bullish trend reversal patterns. Bulkowski* reports that 95% of these patterns are successful and make an average gain of 38%. It forms after a downtrend and is characterized by three troughs with the center trough lower than the two adjoining troughs.

We will conduct our own back testing on this pattern and publish results in the near future.

The neckline is a line drawn between the two intraday highs between the peaks. We recognize two types of head and shoulder bottom, depending on the slope of the neckline. We do this so we can recognize a breakout price and issue alerts when this price is met.

When the neckline is flat or slopes downwards, the breakout price is calculated as the point where the neckline intersects the price line following formation of the right shoulder. It is at this point that the pattern is completed and a long position could be opened (or a short position closed). At this time we can calculate a 'target' increase which is the distance between the center trough's low and the neckline. Bulkowski* estimates this target is reached 83% of the time.

If the neckline slopes up, then it is possible that it will never intersect the price line following the right shoulder, so we use an alternative method of determining a breakout price. In this case we use the support level between the left shoulder and the head and calculate the target price as the difference between that support level and the center trough's low.

Pattern Recognition

Our algorithm will recognize a head and shoulders bottom pattern when the following conditions are met.

1. The stock must be in a confirmed up trend before the pattern begins. An uptrend exists if the the left shoulder is at least 30% lower than the high in the previous 6 months (120 trading days).
2. The pattern width, shoulder-to-shoulder, must be 6 months (120 trading days) or less.
3. The head must have occurred within the last 6 months (120 trading days).
4. There must be approximate symmetry to the pattern. We determine this by requiring that number days between the shoulders and the head (a and b in the diagram) must be within 50% of each other.
5. There must be a noticeable peak between the left shoulder and the head (c). We chose an arbitrary minimum of 2%. This is measured from the left shoulder intraday low to the intraday low at the left neckline.
6. There must be a noticeable peak between the head and the right shoulder (d). We chose an arbitrary minimum of 2%. This is measured from the right shoulder intraday low to the intraday low at the right neckline.
7. For downward sloping necklines (Type 1), the breakout price is the the neckline value on the date of the last close.
8. For flat or upward sloping necklines (TYpe 2), the breakout price is the value of the intraday low at the left neckline.
9. The last close must be below the breakout price.
10. The minimum 50 day average volume must be at least 500,000.
11. The target % increase must be at least 25%.

Investment Advisors Using our Service

TradeRight Securities, located in a suburb of Chicago, is a full services investment management company and broker/dealer. They have been a subscriber, and user, of BreakoutWatch.com for some time now. They practice CANTATA and use Breakoutwatch.com as a “research analyst”. You can learn more about TradeRight Securities at: www.traderightsecurities.com. If you’re interested in speaking to a representative, simply call them toll-free at 1-800-308-3938 or e-mail gdragel@traderightsecurities.com.

PivotPoint Advisors, LLC takes a technical approach to investment planning and management. A breakoutwatch.com subscriber since May, 2004, they use breakouts, market signals, and now TradeWatch to enhance returns for their clients. Learn more at http://pivotpointadvisors.net or contact John Norquay at 608-826-0840 or by email at john.norquay@pivotpointadvisors.net.

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