Warning: This post may cause shortness of breath and dizziness for iFreaks.

If you look at a longer term chart of Apple, it’s easy to spot the massive head and shoulders pattern forming. It hasn’t completed the pattern (yet), but it’s following all the rules thus far.

When analyzing long-term charts for head and shoulders patterns, there are rules: you don’t just draw two shoulders and head and call it a head and shoulders. Longer term charts get messy and sometimes create disfigured shapes that cause many novice traders to assume that the stock is forming a disfigured head and shoulders. You need to use other indicators, like volume (which is pivotal in this case) to assist you. Don’t go crazy though, analyzing 20 different indicators to test your theory, keep it simple with volume, RSI, MACD and if you must, Stochastics and Oscillators.

Now that I’ve said my piece, let’s get started:

To make it easier, I’m going to go through 5 steps on what makes a head and shoulders and why Apple could potentially be in one of these patterns:
Step 1: Stock in an Uptrend

AAPLThere needs to be an established uptrend prior to the formation of a head and shoulders. I’m sure everyone reading knows about Apple‘s run since it bottomed after the 2008 sell-off. Let’s move on.


Step 2: Euphoria

AAPLAt some point in the uptrend, there needs to be a buying frenzy where volume is above average for a couple weeks. This run-up forms a minor top (the left shoulder). If you look at Apple‘s chart, volume spikes as the stock enters a euphoric buying stage after breaking through the upper band of it’s multi-year channel.


Step 3: Volume Fades and Left Shoulder is Complete

After the stock formed a short term peak, Apple declined on moderate volume. The bounce, that will later form the head, took place in an area that was previously minor resistance (later turned support in the weeks that followed). Apple spent a month around the $522 area before resuming its uptrend, meaning it’s an area that every technician should pay attention to. The bounce after the formation of the left shoulder was brief, but met with unattractive buying volume. When Apple began forming the head, volume during that rally was much lower than when Apple began forming the left shoulder.


Step 4: Overreaction

The formation of the head and the volume that comes with it is a big tell when analyzing for a head and shoulders pattern. When looking at the weekly chart, Apple sold off so violently that it temporarily pierced through the upper band of the multi-year upward channel. Also if you look at the MACD, it registered as a negative divergence (made a lower high) before the recent sell-off occurred.


Step 5: What Needs to Happen Now

AAPLWhat happens next is key. Apple needs to rally back up to $620-$630 on low volume, fail, and then drop back down to $522 with such intense volume that it’ll be obvious that everyone wants out. The volume from the completion of the right shoulder will exceed the volume from the latest sell-off (the completion of the head), especially when it breaks down below the $522 neckline. What could break its fall would be the lower band of the multi-year upward sloping channel. If not, the official target stands around $340 ($705-$522= 183, $522-183=$339). I would like to point out that if it ever got down that low, around $354 is MAJOR support (I did my math on that calculation four times even though I knew it was right the first time).


A monthly chart of Apple shows that it’s likely to produce a bullish hammer. But if you look at the MACD, it shows that the insane bull-run may be in trouble.


Apple‘s RSI also shows trouble ahead, it made a lower high while Apple continued to trade higher and broke below 50 for an extended period of time (last time that happened was in 2007). Another support level to keep on your radar is Apple‘s 50 day (weekly) simple moving average, it bounced off of that level for many years (it was unable to bounce around that point during the latest sell-off).


SPXIf you look at a monthly chart of the S&P, it’s obvious that rallies are getting shorter and shorter as we go up.


Want to make sure everyone understands that this is a technical move, I am not recommending that you short Apple based on fundamentals. Growth may be slowing a bit and margins could contract in the upcoming quarters, but Apple is in no way an expensive stock when compared to its peers (it’s actually cheaper than Intel [$INTC]). What you have to ask yourself is what the overall market environment will look like if this scenario comes to pass? Apple affects the entire market when it moves, this pattern could serve as a precursor to a more scary move in the S&P. In my opinion, I think the pattern could happen if: the US goes over the fiscal cliff, something happens in the EU/China or a major war in the Middle East. Who knows, maybe Apple‘s fundamentals deteriorate next year. I’m not a fortune teller, I just read charts. Hope this post helped.

Questions? Comments? Leave me a reply.

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