A broadening top or megaphone formation is a rare but potentially important technical pattern that is characterized by increasing price volatility and is depicted on the chart by two diverging trend lines. One trend is denoted by a series of rising higher highs and another by declining lower lows. A broadening top pattern is considered both a reversal and a continuation pattern. The pattern occurs when the market is highly volatile, and traders and investors are not confident about the market direction. Normally this pattern develops near a major market top or a major bottom. In general, after a strong rally it is often a warning of an impending very large bearish reversal formation. In the past 2-years, many of the key U.S. Indexes have transitioned into broadening tops/megaphones patterns.
S&P 500 Index (SPX – 2,237.40)
Although this may have not been a classic broadening top/megaphone pattern as SPX did not fail at 3,061 (11/1/19). Nonetheless, the breakout above 3,061 may have been a false breakout or a bull trap as investors rushed into SPX on the expectation of the start of the next major rally. However, the ensuing sudden and sharp reversal has now broken below 2,346.58 (Dec 2018 reaction low or point D) and 2,351.94 (pivotal 38.2% retracement from the 2009-2020 rally). This breakdown is technically significant as it now warns of the next sustainable decline toward 2,030-2,110 (50% retracement and the extension of point BD). Below this render SPX downside targets to 1,810 (Feb 2016 low), 1,708 (61.8% retracement), and then 1,665 (broadening top breakdown projection).
Although it is difficult to forecast with any accuracy the extent of an external/exogenous event-driven bear decline, we must recognize the Feb-present COVID-19 Pandemic bear decline may lead to a global recession and hence an extreme bear decline. Under this scenario, we may have to review the Oct 2007-Mar 2009 global financial crisis as this was one of the greatest bear market decline of our era SPX suffered a devastating collapse of -57.69% over 17 months.
If you recall, this bear decline witnessed three phases of selling exhaustion before finally recording a market capitulation bottom at 666.79 (Mar 2009). Phase 1 was a devasting 46.86% decline from Oct 2007-Oct 2008. Phase 2 was another stunning 26.49% market sell-off that led to a second lower-low pattern in Nov 2008. Phase 3 was a repeat of Phase 2 as the failed oversold rally faded during Jan 2009. This led to the third and final lower-low pattern as SPX plummeted -29.43% thereby establishing a capitulation bottom in Mar 2009.
It would appear Feb 2020 to present bear decline is more advanced and significantly faster than the 2007-2009 bear decline. The speed of the decline and the heightened volatility over the past few weeks suggest that we may not need 17-months before a major bottom occurs. Rather, we contend given the sharp decline over the past month, SPX may be headed toward its first lower-low pattern similar in scope to that of the prior Oct 2008 lower-low (i.e., 839.80 or -46.9%). It is also important to understand, bear market rallies can sustain sharp and explosive oversold rallies. Remember these technical rallies are not only fleeting but will fade and revert to its primary and prevailing downtrend. It is only when a capitulation bottom has developed (i.e., Mar 2009 - 666.79 bottom) when all the sellers have sold the market that the selling pressure exhausts itself and hence the climatic bottom.