Nice rally back up to test Head-and-Shoulders Top Neckline.

Today's SPX rally is a textbook retest of the Head-and-Shoulders Top (HST) Neckline (NL). The minimum objective of the HST is down to around 825 (HST-OBJ). We also have a downtrend line (R1) appearing to form.

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Patterns in the indexes are often not perfect and as I've always said 75% accurate at best. If we assume that this pattern is going to be accurate (which I believe it will be), we could possibly drop obviously tomorrow after the NL retest and move quickly down to 825. Another possibility is the imperfection scenario whereby the SPX moves higher to R1 and is not properly resisted by NL. Also, the SPX could move sideways for a while and eventually tag R1 while still not closing above NL. There's really no way to know which of these cases will unfold. But I do think the next significant move will eventually be down to at least 825 where I'll be looking at re-entering long with accounts not managed by mechanical methods.

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Another interesting point is that around holidays the financial data is usually filled with errors for some reason. In the chart above there is no downside opening gap visible on the 7/2/09 open (gap?). But in the intraday chart it's clearly there at 922 to 924. I believe it does exist and so it remains an unfilled overhead gap.

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Bottom line is I'll be expecting the drop to 825 and as we get close, I'll develop a buying strategy.

Will most likely exit today.

I will be using the same exit rule today as I posted yesterday. As of now (1:30p Mountain), that would cause me to exit to 100% cash with all accounts not managed by mechanical methods.

Testing Head-and-Shoulders Top (HST) neckline.

The SPX is trying to confirm a rather large Head-and-Shoulders Top (HST) by closing below the neckline (NL). If the HST is confirmed I'll expect a drop to at least 825 (HST-OBJ) which isn't something that I'm willing to ride out. Therefore today, if the SPX is at or below 887 (which is today's early low) at my fund cutoff time (~10 min before the close), I'll exit to 100% cash with my accounts not managed by mechanical methods.

I do have quite a bit of hope for a reversal today back above NL and thus no confirmed HST. We have two unfilled gaps overhead (G1, G2) which should tend to resist further downside. We had a late-day sell off before the holiday that took out extremely minor support at the level of the expected downside objective from the 7/2/09 open which gapped down and out of an uptrending channel. (Channel break downside objective = CH-OBJ). Then we opened gap down this morning.

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Right now (11:45am Mountain), the SPX is trying to move higher to fill the gap G1. If this happens too early in the day (like now), we could get some selling which would move the SPX down to lows at the close. The action near the close today is going to be very interesting. If buying can come in late to close G1 and the day closes up to near today's highs, I'll expect more upside to fill G2 at over 920.

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On the other hand, if we close down near today's low, I think the HST will be considered confirmed and we should move lower to at least 825 eventually. I won't necessarily expect the drop to occur immediately and there may be another move back up to NL which will be an obvious exit point if we miss this one.