A note on Head and Shoulders

11/09/2009 by Philinje.

There has been a lot of talk about the “reverse” Head and Shoulders pattern in gold, in dollar terms.

One reason Ron Rosen is putting more weight on the C leg correction scenario is that he thinks the “reverse” H&S pattern is rubbish. That pattern would normally form at the bottom of a correction, indicating a likely reversal. Instead, this one has formed at the top of a major move up that topped in March 2008.

However, there is a version of the H&S that could possibly apply here, which is the continuation H&S. This typically forms during a move up as a kind of stalling pattern. As such, it tends to resemble a consolidation and is often flatter in shape. Sadly, this one is anything but flat. The first leg down that ended last October is quite steep - $1033 down to $681.

The pattern that Ron thinks applies in this situation is a regular flat or an extended flat correction. Both are ABC corrections and it’s clear we may be at the top of B right now or soon. If B goes above the beginning of A, meaning $1033, then an extended flat correction is more likely, which means C will end lower than A or below $680. Otherwise, if B stays around $1033 or lower, C may end at roughly the same level as A.

Wave counting is from the discipline of Elliot Wave, which is quite popular among technical analysts. However, EW is notoriously loose, meaning interpretations can vary a lot depending on someone’s bias or due to the phenomenon of “fitting the data to the theory.” I am not an expert on EW but what I have seen among those experts is a tendency to revise their views constantly as the market reality plays out.

Ron Rosen’s strength is that he uses Delta as a timing tool, which tends to be more solid than EW. Then to the degree appropriate he fits EW to Delta timing. He is one of the best gold analysts around because of this approach and also because he has been in the business more than 50 years. That’s why I pay attention to him.

The problem with Delta is at the beginning of a cycle, the turning points can invert, more than once. So the whole progression of highs and lows can be reversed. This is usualy not resolved until 1/3 or 1/2 way through a cycle. The longest time interval of Delta points is one or more years,  meaning a cycle of multiple years, and when gold topped in March 2008 the movement was difficult to fit against the first three long-term turning points. There is still some ambiguity.

The current prognosis is that we are topping right now or soon at a long-term turning point and then moving down into the next one, which theoretically would arrive next year. However, it is possible (though unusual) for the next long-term point to arrive very soon after the one before.

This is part of the reason that Ron has switched his stance to say that a major correction is still in process and a C leg down will form, either by early October or later. If we go below $830, in my opinion the correction will progress further and take longer. In fact, in that worst-case scenario the parabolic move will be delayed significantly.

So we’ll have to see. We could see a higher top in gold by end of September, but if it stalls at just above $1033, the longer C leg down comes into play.

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