Scary head and shoulders formation could be a warning sign for Nasdaq

Traders work on the floor of the New York Stock Exchange.
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Traders work on the floor of the New York Stock Exchange.

There's a nervousness in the market as corporate earnings season begins, but traders watching the negative technical formation building in the Nasdaq may be feeling even queasier.

A potential head and shoulders pattern is forming in the Nasdaq Composite – which could be signaling a reversal. With Monday's sell off, the downside of the second shoulder was being drawn and the futures were forwarning of more declines Tuesday.

"If the pattern follows, it will go down and test the starting point on the first shoulder," said Justin Walters, co-founder of Bespoke. "There's no real guidance into how much it will be fall."

The Nasdaq Comp fell 7 points to 4988 Monday. Bespoke pointed out the formation in a note and said while technical analysis is just one approach, the chart suggests more weakness ahead in coming days for the Nasdaq Composite.

"If the comp doesn't hold 4960, I think people will start looking at this as the right shoulder forming," said Scott Redler of T3Live. com. "If it does hold, it looks pretty healthy…I think it's too early to say that's a head and shoulders."

Redler said 4955 to 4970 is the area momentum traders will be watching. "To me it doesn't look bearish yet," he said.

Many times heads and shoulders patterns are unfulfilled.

"It's something chartists and technicians are following, so it's worth pointing out ...but it's only one factor. We're keeping our eye on it, but it's not the be all and end all for the bull market," said Walters.