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The Dow is on the Brink

Written By Brian Hicks

Posted March 7, 2008

The headline this morning said it all. “Employers Slash Jobs by Most in 5 Years” it read.

Digging deeper we learned that some 63,000 jobs were lost in February. That’s on top other bad reports from previous months.

The result is that the DOW on now firmly on the brink this morning of a key technical level-12000.

It’s a level that I wrote about last week in my weekly letter to my Quantum Confidential readers.

But because I think that it is so important I’ve decided to put it up on blog today, now that the Dow futures are down over 100.

The letter was first published on February 29. But its was more a of warning than anything else.

Here’s what I wrote:


“As I told you some weeks ago, one of the chart patterns that I find to be reliable more often than not is the head and shoulders pattern.

It’s a reversal pattern that can either be bearish or bullish depending upon its formation.

In fact, back on January 4th I wrote about the same pattern as the Dow flirted again with the 12800K level off of the earlier highs of around 14000.

The chart looked like this at the time:


And here’s what I wrote about that chart in regards to a head and shoulders top:

“And today we are getting closer to the big one–the 12,800 level.

What makes it so big is that for the most part it has provided a certain level of support. Breaking it to the downside, however, could lead to a much bigger drop.

More worrisome is the chart pattern in the Dow. Because while it’s not perfect, it is beginning to take the form of a head-and-shoulders top.

That’s a classic pattern to the downside if it breaks the neckline, which in this case is the magic 12,800 mark that we’ve been talking about.

That is why 12,800 is so important. It needs to hold.

Because if it doesn’t, a further drop to the 12,000 mark could become more likely.”

Of course, it was only about three weeks later that the Dow did just that closing at 11,971 on January 22 after falling as far as 11,508 in intraday trade.

That’s a day that I’m sure that you will remember.

But I don’t bring it up again so that I can simply beat on my chest. I bring it up because I’m sorry to say that it looks like it could be happening all over again now at the 12000K level.

Ominously, another head and shoulders top is forming as I write, this one going back to September ’06. (The Dow by the way is down over 250 points so far today)

So here’s the chart that has me so worried.


But before I go on I’d like to give you a quick education on the worrisome pattern.

So what does a classic head and shoulders top look like?

As depicted above, the classic head and shoulders top looks like a human head with shoulders on either side of the head.

The first point (1) – the left shoulder – occurs as the price of the stock in a rising market hits a high and then falls back. The second point (2)- the head – happens when prices rise to an even higher high and then fall back again. The third point (3) – the right shoulder – occurs when prices rise again but don’t hit the high of the head.

The key to the pattern, however, is the neckline which in this case is 12000. The pattern is complete when the support provided by the neck line is broken.

This occurs when the price of the stock, falling from the high point of the right shoulder, moves below the neckline. Technical analysts will often say that the pattern is not confirmed until the price closes below the neckline – it is not enough for it to trade below the neckline.

Calculating the downside target then is just a simple matter of the math. To figure it out, you subtract the high of the head (roughly 14000) by its distance to the neckline of 12000.

That gives you a figure of 2000 points. Then you subtract that same 2000 from the 12000 neckline to arrive at a target of 10000.

For example, using the chart above from January, you would have subtracted 12800 from 14000 which would have yielded 1200 points. That would have delivered a final target of 11,600 (12,800-1200), which is roughly where the Dow bounced that day.

Kind of neat huh?

But, of course, as the math describes above, if the current pattern does indeed form a successful head and shoulders top this go round it likely means the Dow could go as low as 10000 in the aftermath.

That’s why I continue to insist that holding the 12000 level on the Dow is as critical now as it has ever been. A drop to 10000 would be another 16.6% to the downside.

And if that happened, it would make for roughly a 30% pullback over all.”


Will it happen? I don’t know. But it is food for thought.

By the way….the crucial level on the S&P was 1310. It closed below there yesterday.