I don't think stocks have broken their long-term upward trend but that's a worry that means this market will take a while to base

08/11/2011 12:30 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

You’ll be hearing a lot of talk over the next days and weeks from the technical analysts about the damage that’s been inflicted upon the condition of the markets. That’s one reason, they’ll say, that this market won’t bounce back immediately from its extremely oversold current condition and begin a new rally.

But what does that mean when you translate it?

Actually, it’s pretty straightforward. What the technicians are saying is that the market’s plunge has taken stocks down to levels that make it hard to tell whether this is a short-term correction in what is still a market that is trending upward in the longer term or if this drop has broken the longer-term upward trend and the market is about to drop further.

For a while it was possible to believe that this decline would take the Standard & Poor’s 500 back to its November 2010 lows near 1170. That level has now been taken out, spooking anyone who thought 1170 was the bottom—and who bought on that belief.

The next likely bottom that shows up on the charts is around 1020 to 1060 where there is a lot of support represented by the stop seems to be around 1020 to 1060 where there’s a lot of chart support represented by the late August, July, and February 2010 lows. Those levels represent another 5% to 9% drop from yesterday’s 1120 close on the S&P. That’s a significant loss from here but it’s not earthshattering.

If it’s the end of the drop. But a big decline like this brings out all the doom and gloom that lies in every investor’s heart. And I’m hearing talk of a return to the March 2009 low at 683. I think that’s unlikely—I think it’s fear speaking. But if the market did unwind the complete gain from the 2009 low, it would certainly shift the long-term trend from up to down. Which is one of the worries that are weighing on the market.

If investors can’t tell where the bottom might be, you’ll understand why they might be reluctant to start buying immediately. Yes, the market is oversold, but oversold markets can get even more oversold before they bounce or rally or whatever.

What ends this kind of uncertainty?

Days of volatility that don’t actually puncture any new support levels. In other words investors need to see stocks move down to test support levels, and then move back above support without setting new lows. That kind of market action would gradually build confidence that stocks are just in a correction and not in some new longer-term downward trend.

August isn’t exactly the best of times for building a new base like this. Lots of investors—individual and institutional—are on vacation and therefore stock market volumes are below normal levels. (For example, institutional investors are certainly watching their portfolios but they’re not rushing to put on new positions.) Those reduced volumes mean increased volatility and bigger swings in stock prices. When emotions are running as high as they are right not, those bigger swings can themselves add enough fear to the markets to take prices down another step.

What I’m looking for in this environment isn’t a big up day that reverses the trend but rather lots of days of moderate action—both up and down—that gradually convinces investors that buying at today’s low prices isn’t an exercise in catching a falling knife.

 

 

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