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Stocks Appear Headed for a Genuine Correction

With so much technical damage done in such a short period, it's time to employ bearish strategies


Stocks opened slightly higher on Monday, but the bounce lasted no more than a half hour before sellers again dominated the trading floors. A midday rally regained much of the early loss, but heavy selling in the last 30 minutes turned the major indices decisively negative.

The Nasdaq, which is populated with high-P/E stocks in the technology and biotech industry, was one of the first indices to fold. Some analysts blamed the continued selling on an emerging markets sell-off last week that resulted in the worst week for the bulls in over two years.

Most sectors closed lower with the exception of the defensive sectors like utilities and telecommunications. But Apple (AAPL) closed up 0.81% ahead of an after-hours earnings report. And Caterpillar (CAT) rose 5.94% after better-than-expected earnings.

At Monday’s close, the Dow Jones Industrial Average was off 41 points at 15,838, the S&P 500 fell 9 points to 1,782, and the Nasdaq lost 45 points at 4,084. The NYSE traded a total of 4 billion shares, and the Nasdaq crossed 2.4 billion. Decliners outpaced advancers on the Big Board by 2.8-to-1, and on the Nasdaq, decliners were ahead by 3.4-to-1.

Dow Chart
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Chart Key

The blue-chip Dow industrials sliced through their 50-day moving average on Friday and continued south Monday, holding just above the support line at 15,720. The next support zone is broad, spanning from 14,700 to 15,720, and it includes the venerable 200-day moving average at 15,444.

Nasdaq Chart
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After achieving a new 13-year high on Wednesday, the Nasdaq has plunged through the inflection point at 4,082 and the important 50-day moving average at 4,085. It is now close to breaking the intermediate support line at 4,036, and MACD is on a sell signal.

Conclusion: Analysts are blaming a strong yen, weak emerging markets, poor employment numbers, and a host of other factors for the recent sell-off. But much of that was known before the last four days and is really irrelevant. To a technician, the stock market is telling us that the danger flag is flying, and in my experience, that occurs because of what we don’t know.

I had hoped that the flat market of the first several weeks of the year was merely the result of a strong performance in December. It appeared that institutional buyers were standing aside, waiting for the market to digest the gains with a broad consolidation and then drive the indices to new highs, but it was not to be.

Unless a quick upside reversal can take the S&P 500 above the line at 1,813 and its 50-day moving average at the same level (see yesterday’s Daily Market Outlook), stocks appear to be headed for a genuine correction.

The Nasdaq broke both the inflection point at 4,082 and the 50-day moving average at 4,085. The bulls are hoping for a rebound from the important intermediate support line at 4,036, and they may get it. But so much technical damage has been done in such a short period that we must temporarily move to the bearish side and sell into rallies.

The long-term trend is still bullish, but both the short- and intermediate-term trends are now down, and so defensive strategies should be taken. If you are an investor, sell calls or buy puts to protect gains. But if you are a trader, then you should initiate more aggressive short-selling and put buying strategies, but only on rallies. Chasing this bear without regard to price could catch you in a bear trap.

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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