Tuesday, February 5, 2008

State of the Market - 2/5/08

A significant down day today for the markets, as they gapped lower, sold off for the rest of the day, and closed at the lows of the day. I heard many people calling for a pullback right now but I believe this goes beyond just a simple pullback. 3% down days on the Nasdaq and S&P 500 are not simple pullbacks. Volume was also heavier today. One down day like yesterday is no big deal when the volume is weak. But if a big selloff comes on heavy volume, that is certainly not a good thing if you are hoping the market is going higher. The volume wasn’t huge, so maybe the bulls can hang their hat on that, but if this is the start of a move down, it is wrong to think the volume will be extra high right here. It will grow as more people get caught and want to get out. Technically, the indexes also appear to have broken lower out of what might be a bear flag pattern, and in doing so on higher volume, it implies that we will continue lower here. There is no guarantee of that, but that is the expectation I have right now. They say it often takes a few days for the true trend to be established after a Fed decision, and after two big down days starting off this week, I would say the market may be telling us now what it really thought about the cut last week.

S&P 500
Charts from Telechart, Courtesy of Worden Brothers, Inc.

The XLF also had a big breakdown today, falling back below its 50 day moving average after spending three days above it. I heard a lot of people calling for the bottom in banks this past week and while that could still be true I guess, I find it hard to believe based on today’s action. Volume wasn’t quite as large as I like to see on a true breakdown, so maybe we’ll get a quick bounce tomorrow, because I am sure some of the CNBC guys will be telling us all how this is another chance to get in the great financial bargains out there. For my own thinking, however, I will be looking at the SKF for a possible entry here with a stop below its 50 day moving average.

Charts from Telechart, Courtesy of Worden Brothers, Inc.

I dipped my foot back in today and established a few shorts that were breaking back down below their 50 day moving averages. After losing discipline on entries last week, I started some midday and then added to them at the end of the day. Last week, I entered all at once and that set me up to take much more risk. I don’t know for sure that these shorts will work, but their 50 day moving average will act as a close stop loss level for me to exit if needed, and I looked for higher volume on these breaks. A lot of the patterns look similar, and several are stocks I have already shorted several times this year. I need a few winners here to get some confidence back – hopefully that will happen.

Charts from Telechart, Courtesy of Worden Brothers, Inc.

So is this the end of this bear market bounce? I don’t know for sure with this market – maybe the Fed can come back in tomorrow and cut rates another 75 basis points. It’s been almost a week, so I think we are due. In all seriousness, I think the bounce is likely over. The Nasdaq has put in a 9.8% rally and the S&P 500 has put in a 10% rally in a little less than two weeks. We were getting or were already overbought. A pullback here would certainly not be surprising. I think the most important thing to look at is the volume. If we get several other high-volume selloffs with volume building each day, then we could be breaking the recent lows soon. If the pullback comes on lower volume, then maybe we will just test the lows and hold them. I am mentally preparing myself to accept being wrong here because of last week's craziness, but based on today’s volume, things certainly don’t look good for the bulls. Good luck out there.

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