Bearish Engulfing Candlestick Pattern May Signal End of the Rally

The eminent Philosopher-General of the Baseball Diamond, Yogi Berra, has been quoted often as saying that “It ain’t over ‘til it’s over.”  That caution applies well to the stock market and to its accompanying stock Indexes.  It’s not possible to count the number of times that our Candle charting work gave us reason to believe that a price trend in the stock market had run its course – only to be fooled again.

It’s no different this time.  We have been patiently waiting for a credible Candle chart signal that the Great Rally of 2009, which began on March 6, has come to an end.  Various forecasters, ourselves included, believe that it is possible that the Dow Industrials could reach 10000 before the Rally tops, rolls over, and the advance in prices finally comes to a reversal.

Of course, opinions vary as to the nature of the Rally itself.  The more optimistic commentators believe that the Rally is probably a resurgence of the great bull market which came to an all-time top in October 2007, whereupon it gave many indications of a permanent reversal of trend.  Others, like ourselves, believe that there was a massive change of underlying trend in October 2007, from Up to Down, which means that this Rally has not been evidence of a resurgent (but still alive) bull market, but rather that it is only a bull rally in an underlying bear market.

The difference between the two outlooks could hardly be more fundamental.  Each of them colors everything its proponents consider when watching the development of prices and Candlestick chart patterns during this Rally.

Our own belief is that the Rally will come to an end somewhere between present prices and 10000 in the Dow.  Price action today has been very informative, and hints that we may have seen the top.  Whereas prices across the major Indexes are down from yesterday’s close, it appears that the “big chips” (large-capitalization issues) are holding up better than the mid-caps, the small-caps, and the NASDAQs.

We have been watching the candlestick indicators all during trading hours today.  A bearish “Dark Cloud Cover” pattern developed early, which morphed into an “Outside-Down Day Bearish Engulfing Pattern” as prices continued to decline.  At the Close, assuming that our incoming electronic data are accurate as of this writing, it appears that the latter will be the “Daily” candlestick formation which will go forward into tomorrow.  I’m almost ready to go out on a limb and call this the end of the Rally.

The identification of Candlestick reversals is one of the most challenging and enjoyable aspects of market-watching.  Hardly anything can be more satisfying than ferreting out a reversal pattern even before it is born, and then observe it having an effect on subsequent price action exactly as one has predicted and as the literature describes the usual products of the pattern.

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William Kurtz

August 5, 2009