Over the weekend I was browsing through Technical Analysis of Stock Trends” by Edwards and Magee, and I found myself researching bear flags.I had noticed this pattern forming on the major indexes and had drawn the support/resistance lines on a few charts in one of my watchlists. and discovered something quite disturbing about how this chart pattern typically plays out. It’s ironic that I was going to do a post about this over the weekend but just didn’t get around to it, but these patterns broke down today with the major sell-off, so I thought it important to talk about the implications of such a move.

All three charts below look identical with the major breakdown coming in September and over the past few months we’ve been consolidating in a bear flag. So If you look at this pattern you could break it into 3 sections with them being:

  1. First fall
  2. Bear flag (consolidation)
  3. Second fall

From “Technical Analysis of Stock Trends” it reads regarding flags and pennants,

This type of pattern is fairly common in fast moving markets. The extraordinary point about flags and pennants (and sometimes other consolidation patterns in fast moves” is their tendency to form almost exactly halfway between the bottom and the top.”

Should we just be halfway through the current move down as this analysis is suggesting we are a long way from the bottom. Doing some rough calculations as it never is going to be exact in the face of a potential mammoth wave of selling that could be coming, here is the rough estimates. Remember that tops and bottoms tend to overshoot the analysis, so it’s likely to add another 2-3% for downside slippage.

Potential final bottom

Nasdaq 750

SPX 475

DJIA 5600

One aspect to this analysis that jumps out at me is that the Dow could be showing some relative strength in all of this selling should these projections hold up. I tend to think that makes sense as there always has to be some money in the markets and they (mutual funds, retirement accounts) most likely will be in dividend paying stocks that are safe near a market bottom. Techs would be wrecked with it showing another 50% loss from Friday’s closing levels and the SPX would a be near 40% drop.

No matter when the bear market ends I think most veteran traders know this has a long way to go and these projections could be a big enough drop to satisfy the hungriest bears out there. While I’m not going to base any of my trading decisions on a chart forecast as I’m not one to say the market is going to do this or that next year, however I did find this analysis interesting and thought I’d share it.