NDX Rears Its Ugly Head-And-Shoulders

The easiest money has been made over the past week with the distribution scenario. Building the position around the Nasdaq 100 (NDX) 2040 level and riding that short-exposure down to 1990 was the first profit target. Then we got a lot extra, as the NDX moved down to 1945, under expectations for 1950 to hold and create congestion on Friday. Now that the 100-point move lower from the week prior has offered the so-called "easy" money, the next couple of weeks will try both sides of the tape.

It appears that the index is starting to form the dreaded head-and-shoulders technical pattern. You can see on the daily chart that the left side of the shoulder has formed between 1950 and 2000. The brief break above 2000 to fill the gap at 2040 has provided the head. The most recent price behavior in the index is beginning to form the right side of the shoulder. A move back to 2000 resistance that holds as such and a break of NDX 1945 would confirm the pattern that bulls hate to see.

For the past two weeks, I have been talking about the probability for further downside should the anticipation of a better second half begin to wane. At some point, the expectation of better economic data and earnings data would have to lead to actual results. What I've been looking for over the past two weeks is either the selling of negativity, showing that investors were less willing to buy up for the anticipation of a better second half, or for congestion after good news. Again, this would show that investors are okay to buy the dips, but they wouldn't be as confident with the buy high-sell higher approach.

The consumer confidence data kicks off a week of a number of economic reports that the market will key off of for the short week. The ideal scenario will be that investors bid the markets higher back to NDX 2000 to create the right side of the shoulder of the technical pattern.

At this point, I would like to see investors selling long exposure and begin building short-exposure again for the break of NDX 1940 on a closing basis to confirm the head-and-shoulders pattern. If this happens, the index could easily head back to the 1875-80 level. There is an open gap still at NDX 1845 that would be the ultimate downside target based on the technical pattern confirmation.

For Tuesday, I'll be looking for a slow two-day rise back to NDX 2000, where any current short-term long-exposure profits can be taken. At that point, I would be looking to build short-exposure again for the next stronger leg down over the rest of the week.

A close under 1940 would confirm expectations, while a move back to NDX 2040 would negate this head-and-shoulders pattern. If the index closes under 1940 without first offering the move back near NDX 2000, then it will be difficult to establish new short-exposure without offering a higher degree of capital risk.

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At the time of publication, Schumacher had no positions in the stocks mentioned, although holdings can change at any time.

Chris Schumacher is a financial trader, speaker, writer and co-author of Techniques of Tape Reading. While Schumacher cannot offer specific investment or trading advice, he appreciates your feedback; click here to send him an email.