Can Stocks Hold the Lows?

08/19/2011 10:55 am EST

Focus: STRATEGIES

Thomas Aspray

, Professional Trader & Analyst

Stocks are facing strong downward pressure, and while a break of recent lows is possible, those who avoid panic selling now could get a better exit point on a rally in the weeks ahead.

The Eurozone concerns hit the stock index futures very early Thursday, and by the time the regular session started in New York, the selling pressure was already high. The Philadelphia Fed survey hammered the markets even more.

Stocks did firm in late trading, but the selling carried over to the Asian session early Friday with the S&P futures down over 15 points an hour before the opening.

The short-term technical action shows no signs yet that the decline is over, and even though individuals are taking massive sums out of the equity markets, the sentiment is not yet that extreme. The last time investors took this much out of the market was in October 2008.

The most recent American Association of Individual Investors (AAII) sentiment survey as of August 18 shows that over 35% are still bullish. At the 2010 summer lows, the bullish percentage dropped below 21%, so investors can still get much more bearish. The sentiment on the institutional side seems more negative, as more are now looking for another recession.

Clearly, the interest rate spreads in Europe, despite the fears surrounding many banks, are not nearly as wide as they were in October 2008. Technically, the market also looks much better, especially the weekly analysis.

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Chart Analysis: This weekly chart of the Spyder Trust (SPY) and the NYSE Advance/Decline (A/D) line is updated through last Friday (Aug. 12). It shows that SPY spent most of last week below the Starc- bands, which has not happened since May 2010.

  • The major 38.2% Fibonacci support level at $110.41 was slightly exceeded last week. There is a band of support from summer 2010 in the $105-$108 area
     
  • The 50% retracement support is at $102.14
     
  • The weekly NYSE A/D line tried to bounce from its weighted moving average (WMA) last week, but unless the A/D numbers are very strong on Friday, which seems unlikely, the WMA will be likely be broken this week
     
  • There have been a large number of extreme A/D days recently, like Thursday, which makes an equally sharp rebound likely next week
     
  • Though the short-term uptrend (line a) has been broken, the A/D line is still well above long-term support at line b
     
  • This support is derived from the 2009 lows, as the NYSE A/D line bottomed at point 1 in July 2008. It then formed two positive divergences, points 2 and 3, that helped identify the March 2009 lows
     
  • Since the weekly A/D line did confirm the April highs, this support is a key level to watch

NEXT: See Key Daily Levels for SPY, Dow Industrials ETF DIA

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The daily chart of the Spyder Trust (SPY) shows the bounce this week to the initial resistance at $120.50-$121, as the actual high was $121.20. This slightly exceeded the minor 38.2% retracement resistance from the July highs, while the 50% level is at $122.95.

  • Thursday’s close was back below the former uptrend, line a, and the 200-day moving average (MA) is starting to flatten out
     
  • The S&P 500 A/D line has turned lower and looks ready to again test the uptrend from the July 2010 lows, line b

  • The market will need to turn around in the next few days in order for the A/D line to develop a short-term positive formation
     
  • A break of the uptrend does look more likely, as the A/D line could drop to support from late 2010

  • SPY has initial resistance now at $118 with stronger resistance in the $120.50-$121.20 area

The SPDR Diamond Trust (DIA), which tracks the Dow Industrials, looks a bit more positive, as it has a much lower concentration in the financial sector. DIA also exceeded the minor 38.2% retracement resistance at $114.12, but failed below the 50% resistance at $116.64.

  • The major 38.2% support level at $105.46 held on the recent drop. A band of strong chart support stands in the $104-$107 area and then in the $100 area after that
     
  • The major 50% support stands at $97.69
     
  • The A/D line for the Dow Industrials has also turned lower, but unlike the S&P 500 A/D line, it has held above the support from the 2010 highs, line d. The longer-term uptrend (line e) is significantly lower
     
  • There is initial resistance at the gap in the $111.70-$113.38 area with further resistance at $115.46, which was Wednesday’s high

What It Means: It will be interesting to see how the US market holds up until the European market’s close. If we do not get any more shocks after the close, today’s action should not be as bad as yesterday’s.

The most likely scenario is for a test, if not a marginal break, of the August 9 lows in the next few sessions. This could set the stage for a better rebound, and the strength of the next market rally should tell us whether the market decline is going to carry over into the fall.

How to Profit: As I recommended last Friday, “If you have some stocks that have been acting weaker than the market, I would use a rally towards 1,200 to 1,220 in the S&P to get out of them.” Wednesday’s high in the S&P 500 was 1208.

Overall, I think there is a very good chance we will see rally at least back to the 1200 level in the next several weeks, and I would avoid selling with the herd unless it is absolutely necessary.

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