I was scanning some different periods for interesting chart patterns and wanted to share some insights on the structure of the 1987 stock market ‘crash’ in the S&P 500 Index.  Let’s look at the chart of 1987 and then see the few years preceding this move with an Elliott Wave count overlaid on price.

1987 Daily Chart:

Without going into intricate detail, there are a few points I wanted to highlight.

First, notice how price continually respected the rising 20 day EMA both on the upside and downside.  Moving averages, particularly in trending environments, can provide opportunities to enter on retracements against the prevailing trend with a relatively tight stop-loss parameter.  Though it doesn’t always “work,” the structure can be used to supplement other entry and exit strategies.

The moving average orientation throughout most of 1987 was in the “Most Bullish Orientation” possible as price continued to ‘bounce’ off the 20 and 50 EMAs.

However, this structure changed in September.  Price formed a slight negative momentum divergence going into the 1987 price high in late August.  Price then retraced, breaking EMA support just as it had in April & May, which only serves as a warning rather than an official “trend change” signal.

Price formed a lower high just shy of 330 in early October was was a serious warning sign as price then re-broke beneath the confluence support of the 20 and 50 EMAs – another serious warning sign.  The key area to watch was 310, which would have put in a new swing low and officially turned the trend to the downside (having now made a lower high and a lower low).

We broke 310 in mid-October AND the 20 and 50 period EMAs “crossed bearishly” which officially put the ‘nail in the coffin’ of the prevailing uptrend on the daily chart.  Price then retraced to test the confluence crossover zone – I’m calling it a “Cradle Trade” though I’d love a better name for this structure – just before collapsing two days prior to the massive ’shocking’ sell-off that wiped out so many accounts at this time.

Oh, a note – once price fails at the “Cradle Resistance” or “Confluence Resistance” area after having broken beneath the 20 and 50 EMAs, the next automatic target is the rising 200 day SMA which was achieved… and then shattered two days later.

What happened next?  The collapse.

Was it forecast by technical analysis?  No, but the odds had officially shifted to the downside, as price had officially reversed its trend from up to down, having formed a lower high and a lower low; broke beneath the 20 and 50 day EMAs; then failed to break above confluence resistance at the “Cradle Trade” zone (Confluence Resistance where the 20 and 50 EMAs cross).

At a minimum, technical analysis warned of greater downside odds than upside odds, though again it’s easier to anticipate the possible direction of a move rather than the magnitude of the move.

As it turned out, price collapsed to the rising 200 week moving average which also happened to be a confluence Fibonacci target, because index value 220 represented the 61.8% retracement of a significnant swing low in 1984.

In the next post, I’ll examine the weekly chart structure and overlay an Elliott Wave Count to help put the 1987 ‘crash’ into a bit more perspective.

Corey Rosenbloom
Afraid to Trade.com

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