July 25, 2009: S&P 500, NASDAQ Composite, Dow and Russell 2000 have formed a bullish inverse head and shoulders pattern indicating that the market may move higher.

Let us look at the inverse head and shoulders formation and the probable target for the three indices. The charts show the left shoulder, head and right shoulder for the three indices and the time it took to form the pattern. The time taken is shown by the pink upwardly sloping line. 

A white upwardly sloping line shows the neckline of the pattern. Market technicians will point out that a measured move is the level to which prices can rise out of an inverse head and shoulders pattern. Conservative technicians state that prices can rise about 75% of the measured move. The measured move is calculated by measuring the distance from the head of the inverse head and shoulders pattern to the neckline. Then the same distance is applied to the point from where prices break out the neckline to calculate how far the rally can go. 

Our calculations show that the  Dow can reach the 11,200 area, the Russell 2000 can reach the 700 area, the NASDAQ Composite can reach the 2391 area and the S&P 500 can reach  the 1200 area. Conservative technicians would have a lower target area. The measured move is shown by white vertical lines and the red horizontal lines show the target of the current rally. The yellow horizontal lines show major resistance areas that must be cleared for the markets to reach the target calculated by the measured move. It is possible for the markets to reverse from the resistance areas shown by the yellow vertical lines. 

2002-2003 versus 2008-2009

There are similarities and differences between the inverse head and shoulders formation of previous bear market bottom and now. The similarity is that both patterns took exactly 33 weeks to form. The difference is that current pattern is more bullish as the right shoulder is much higher than the left shoulder. In 2003 the right shoulder of the S&P 500 and NASDAQ was not as high from the left shoulder, as it is now. In the case of the Dow and Russell 2000, the right shoulder was lower than the left shoulder.

Caveats

It is possible for the pattern to fail and for the market to resume its downward journey. If prices fall below the right shoulder, it's considered a failure of the pattern. Additionally, any of the resistance areas marked by the yellow horizontal lines can reverse the uptrend. Remember that we are still in a secular bear market and this rally could just be a correction.

Chart Analysis

Inverse H&S