A Rainbow Convergence and a Head-and-Shoulders | Prime Advisors Nook


This week’s chart is the one I’ve been watching very carefully the previous few days and sharing in my Every day Version. It has a number of issues all occurring on the similar time, and presents an important lesson on a few necessary chart evaluation rules.

The primary and extra elementary level is that the S&P 500 only recently fashioned a basic head-and-shoulders (H&S) high construction. A H&S is necessary not as a result of it’s a high (or if inverted, a backside), however as a result of it supplies us with a measuring goal for a value transfer as soon as the neckline breaks. The way in which this precept works is that you simply measure the peak of the top above the neckline, and apply that distance in the other way from the purpose the place the neckline will get damaged, and that measurement offers the target for the transfer. Here’s a diagram:

If the neckline is tilted slightly bit, as it’s on this instance, then the measurement will get just a bit bit extra sophisticated, however it isn’t too laborious to do. On this case, the draw back goal was to round 3900 on the S&P 500 Index. Reaching a H&S goal doesn’t imply that the transfer has to cease; it’s a goal, not a ground. Its goal is to know the place to take earnings on a transfer, if costs get there, which can be not assured. There are failures to succeed in the target.

Within the case of the down transfer into September 2022, the S&P 500 met that goal fairly exactly and has now bounced. It’s a pretty spectacular instance of this precept. And it simply so occurs, coincidentally, that the 3900 stage, which is the H&S goal, has acted as an necessary help and resistance stage greater than as soon as within the latest previous, making it an important place to anticipate help to work once more.

Whereas all of this was occurring, there was additionally the formation of what we name a “rainbow convergence” of the 4 shifting common kind traces within the high chart. Solely two of those traces are precise shifting averages, the ten% Development and the 5% Development. These are exponential shifting averages, and the distinction between them is the McClellan Worth Oscillator. See this hyperlink for how one can calculate the ten% Development and 5% Development.

The opposite two traces are extra sophisticated, however, in my opinion, they’re definitely worth the bother to calculate and embody on the chart. The Worth Oscillator Unchanged stage represents the theoretical value the place the Worth Oscillator could be precisely unchanged from the day earlier than. It acts like a fast-paced common, however shouldn’t be one.

The Sum/10 line is a Summation Index of Worth Oscillator values, which is then divided by 10 to place it again down into the vary of the place costs are. It, too, acts like a shifting common, a slower one, however it isn’t one. See this hyperlink for extra on these calculations:

A convergence of those 4 traces is necessary, however its that means varies in accordance with how costs are behaving in the mean time of the convergence. In a Kind 1 rainbow convergence occasion, an accelerated value transfer serves to tug collectively the 4 shifting common kind traces, and the second of the convergence marks the entry right into a pause interval. That pause will be only a relaxation break, or it may be a reversal. Which one it’s relies on what costs do, and the mission of the pause is to conduct a check of the Worth Oscillator Unchanged line. How that check goes determines what comes subsequent. Seeing costs shifting throughout the Worth Oscillator Unchanged line alerts a pattern change or reversal. Testing and failing to penetrate it’s a signal that the pattern previous to the pause ought to resume itself.

In a Kind 2 rainbow convergence, the worth will retrace again towards the price-time level of the upcoming rainbow convergence, however not retrace past it. The message of a Kind 2 convergence is that the pattern previous the retracement ought to resume itself.

It’s fairly clear by now that the September 6, 2022 low was a textbook instance of a Kind 1 rainbow convergence. Costs bottomed on the precise day that the 4 shifting common kind traces converged. The message of a Kind 1 is that costs ought to pause, that means that the downtrend is on maintain for some time. The mission of the pause is to make a check of the blue Worth Oscillator Unchanged line, which, in the mean time, continues to be a number of factors above the present value stage. So we should always anticipate to see just a few days’ price of a pause within the downtrend whereas that check course of will get labored out.

The enjoyable a part of this second in time is that we’re seeing the simultaneous completion of a rainbow convergence simply as costs have just about precisely reached the measuring goal of the head-and-shoulders construction. Issues don’t at all times work out so neatly, however it’s enjoyable to see these uncommon examples when two wholly impartial charting disciplines come to work collectively.

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