Should You Buy or Sell an Early Morning Rally?

Market's near-term trend, and possibly intermediate trend, is down

By Sam Collins, InvestorPlace Chief Technical Analyst
Dow Chart

On Tuesday, stocks gapped down on a downgrade of five Spanish regions by Moody’s, followed by earnings misses from 3M (NYSE:MMM) and DuPont (NYSE:DD). Commodities were also hit hard with gold futures off 1% and crude oil down 2.3%.

Blue-chip stocks were the focus of Tuesday’s selling, and the Dow Jones Industrial Average showed it by losing 1.82%. The Dow was off 243 points to 13,103, the S&P 500 fell 21 points to 1,413, and the Nasdaq was off 26 points, closing at 2,990. The NYSE traded 669 million shares and the Nasdaq crossed 423 million. Decliners led advancers by 2.7-to-1 on the Big Board and 1.8-to-1 on the Nasdaq.

Dow Chart
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Trade of the Day Chart Key

On Tuesday, a broad liquidation of blue chips drove the Dow through support, now resistance, at 13,275, to just above the next support zone at 13,000 to 13,100. This zone is important since just under it is the uptrending 200-day moving average, and a break of that line changes the intermediate trend. The MACD indicator is oversold but not excessively oversold. Blue chips appear to be weak enough to move lower into the next support zone at 13,000 to 13,100.

Nasdaq Chart
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Even though the blue chips led the September rally, it is the Nasdaq that has consistently been the leader in trend changes. The recent shoulders-head-shoulders (SHS) pattern was first mentioned by the Daily Market Outlook on Oct. 10, and since then, the index has been the market leader. The index has met its downside SHS target, came within 2 points of its 200-day moving average, and bounced from it. Its MACD is oversold and due for a rally.

Conclusion: The better-quality stocks have been trailing the mid- and small-cap stocks lower. The Russell 2000, which is composed of the small-cap segment of U.S. stocks, rallied from 10:30 a.m. Tuesday until the close, and given more time, may have ended with a gain.

Thus, the groups to watch to determine the next move of the broad market may be the small- and midcap stocks. However, near term the overall trend, and possibly the intermediate trend, is down. Therefore, early morning rallies should be used by traders as shorting opportunities until a foundation is laid for a more permanent base of support.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here.

For a list of this week’s economic reports due out, click here.

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