It is difficult to know if the Russian-Ukraine war will sustain for a few more months or last for many years. It is equally challenging to determine if Fed will be successful in containing inflation and creating a soft landing. The Covid-19 pandemic has yet to transition into an endemic. Few can project when life will return to normal. With the above unknowns, it is understandable that investors and traders have become increasingly cautious and defensive.
It is no surprise that technical formations such as broadening tops/megaphones, head and shoulders tops, and rounding tops have appeared in popular market indexes.
A broadening top or megaphone formation is a rare but significant technical pattern. It 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/megaphone pattern can be a reversal or a continuation pattern. It tends to develop when the market is highly volatile. Traders and investors are not confident about the market direction. The pattern is noticeable near market tops or bottoms. After a strong rally, it warns of an impending bearish trend reversal.
In the past few years, key U.S. Indexes have become increasingly erratic, showing signs of confusion and uncertainties, and this is depicted by broadening tops/megaphones patterns.
It is unusual to see two broadening top/megaphone patterns in an important market index. However, the S&P 500 Index currently shows a 2-year pattern (i.e., weekly chart) and an 8-month pattern (i.e., daily chart).
S&P 500 Index Weekly Chart (SPX – 4,500.21)
A classic 2-year broadening top/megaphone pattern developed from 2018 to 2020. The formation is historically a topping pattern. However, it can also transition into a continuation formation.
The reversal occurred on a surge above the top of the broadening pattern at 3,675 on 11/30/21. The breakout suggests 1,201.66 points or an SPX target at 4,877. SPX quickly rallied to 4,818.62 (week of 1/3/22) before recording a negative outside week.
The extension of the broadening top/megaphone becomes pivotal support on pullbacks. The extension of the top of the pattern at 4,061-4,198 provides crucial support. The ability to find support is bullish and hints that the structural bull trend is still sustainable.
The all-time high at 4,818.62 (1/4/22) remains critical resistance. A breakout helps to confirm the 4,114.65 (2/24/22) as a market bottom, setting the stage for the next sustainable SPX rally. Violation of the bottom of the pattern at 4,061 warns of a deeper correction toward 3,500-3,800 (50-61.8% retracement from Mar 2020 to Jan 2022 rally).
S&P 500 Index Daily Chart
A potential broadening top/megaphone pattern has developed in the past eight months. The top of the pattern is 5,112, and the bottom is 4,056, providing key resistance and support. The outcome of this pattern can lead to the next SPX breakout or breakdown.
Since SPX is currently trading near the midpoint of its range, the next few months will likely be volatile and erratic. The outcome will help decide the next directional trend. Above 4,818.762 ( 1/4/22 all-time high) confirms a breakout and signals the next SPX rally to 5,112 (top of the broadening top/megaphone pattern). Above the top of broadening top/megaphone pattern suggests 703.97 points or an SPX rally to 5,816. On the hand, a violation of the bottom of the pattern at 4,056 warns of the next SPX decline to 3,352.