A so-called megaphone top pattern in the U.S. stock market is gaining publicity — often with scary conclusions. Should you trim stocks based on this pattern?

Let’s examine the issue with the help of a chart.

Please click here for an annotated chart of S&P 500 ETF SPY, which mirrors the S&P 500 Index SPX. Similar conclusions can be reached from charts of the Dow Jones Industrial Average DJIA and Nasdaq 100 ETF QQQ.

Note the following:

• As shown on the chart, a megaphone pattern is bound by a rising trend line and a falling trend line.

• A megaphone top pattern usually occurs after a significant rise.

• The pattern is typically characterized by high volatility.

• Traditionally this is considered a topping pattern.

• As shown on the chart, the prospect of the stock market falling to the lower trend line is indeed scary as it can cause major losses for buy-and-hold investors who are fully invested.

• As shown on the chart, price has not touched the down-sloping line many times. This indicates there is the potential of a positive resolution. In plain English, an upside breakout has a fair probability.

• A megaphone top, when properly formed, can be useful in trading individual securities. However, the predictive power for a pattern that is not well-formed for the overall stock market is questionable.

What does it all mean?

Investors ought to be aware of the pattern, but there is no need for dread. Investors ought to keep the following at the forefront of their thinking.

• Follow a proven adaptive comprehensive model that has performed well in both bull and bear markets.

• The stock market is entering a period of negative seasonality. However, this presents opportunities for investors who are holding enough cash and hedges. The Arora Report provides precise levels of cash and hedges to hold under these market conditions….Read more at MarketWatch.

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