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Dorn: Diamonds Are Not a Trader's Best Friend

In our earlier analysis, my colleague Tony Cherniawski and I presented the idea that a Broadening Top Formation had cloned itself several times over as the market sought to extend through the end of 2009. We called this “The Not-So-Orthodox Broadening Top.”

As a follow-up to this analysis, we now present the idea of yet another extension in the rally that may not be totally unexpected.

The quotation attributed to John Maynard Keynes, “Markets can remain irrational far longer than you or I can remain solvent” comes to mind as many traders have thrown in the towel multiple times after expecting an end to this powerful rally.

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The chart above shows the Not- So- Orthodox Broadening Top through mid-December of 2009.

This formation has the look of the Orthodox Broadening Top seen in Edwards and Magee’s Technical Analysis of Stock Trends. Not to be outdone, however, a final broadening formation (black) inserted itself.

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The entire process left a series of false signals for discouraged traders. Volume, that tends to diminish in a bearish wedge, is erratic in a broadening top. There are multiple false breakouts in both directions, also giving false directional signals. This is why so many professional traders and money managers are throwing in the towel. Their accounts have been chewed up by the whipsaw movements within this pattern.

Tony and I concluded that the final point 5 had reversed into what may be best described as an impulsive wave, followed by a corrective pattern that could not regain the prior highs. We posited that this might be the final gasp of a very difficult trading pattern.

It now appears that the broadening top formation has morphed into a wedge formation. While trading volume appeared erratic during the broadening formations, it declined dramatically in the month of December, confirming the wedge formation.

Please note in the chart below that the relatively strong buying volume in January produced a nominal result, indicating exhaustion and distribution. I would posit that point (w) represents the top of the original (blue) broadening formation. It was followed by point (y), representing the top of the second (red) broadening formation. The third extension (z) has changed its form and character to a wedge. The picture in its entirety takes the form of a Diamond Top.

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A view of the Diamonds (DIA) in the chart below shows a very similar result. Although the Diamond formation is not as clear, it has the same properties.

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For those of you who have knowledge of the Broadening Top, Rising Wedge or Diamond formations, the implications are enormous. There are several authors who have written extensively about these technical formations, including Edwards, Magee & Bassetti (Technical Analysis of Stock Trends), John Murphy (Technical Analysis of the Futures Markets) and Thomas Bulkowski (Encyclopedia of Chart Patterns). We have used all of these authors as our sources in an attempt to maintain accuracy and reliability in our analysis.

Tony and I have seen several other analyses that captured portions of the above analysis, but there are no others of which we are aware that summarize the “big picture.”

We stand to be corrected on this statement and welcome any and all feedback in this regard to: janice@thetradingdoctor.com

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Dr. Janice Dorn is the only Ph.D. (Brain Anatomist) and M.D. (Board-Certified Psychiatrist and Addiction Psychiatrist) in the world who actively trades, writes commentary on the financial markets and manages a subscription-based website. Dr. Dorn has been trading the gold futures markets full time since 1993. She has written over 1000 articles on trader and investor psychology, and mentored over 600 traders and investors.She writes on all aspects of trading psychology and provides a real-time trading service on her website: TheTradingDoctor.com.