Look Out Below!

05/06/2010 4:51 pm EST

Focus: MARKETS

Jim Jubak

Founder and Editor, JubakPicks.com

Wow! Or, maybe better, Yeeouch!

In the last hour, the Dow Jones Industrial Average has been down 1,000 points as it fell and kept on falling. Or just 350 points down as it rallied off the bottom.

It closed near 10,500, off about 350, or a bit more than 3%.

My best guess on what’s happening is that the selling of the last two days and the first part of today finally took prices on the major indexes low enough to trigger massive program trading.

In other words, as happened in the 1987 crash, computer programs designed to protect investors from massive losses by selling when prices got too low went into action and in selling created exactly the losses they were designed to prevent.

I’m using program trading here in the loosest sense for computerized trading programs designed to kick in at preset market conditions. I don’t know—and we won’t know until someone takes apart the numbers after the close today—whether the selling was triggered by the price of the actual indexes or by prices in the futures or options market.

As you’d expect on a day like today, gold has rallied—back above $1,200 an ounce—and safe-haven buying has taken prices of US Treasuries up and the yield on the ten-year note down as low as 3.33%, the lowest since December 2009.

Since, in my opinion, technical levels explain the huge plunge that took the Dow down 1,000 points or so (it’s not clear what real stock prices were during the heaviest trading, since exchanges fell well behind on executing orders), let’s look at some of the technical levels that might explain the selling.

Wednesday’s (May 5th) decline left the Dow at 10,868. That was just above the January 19th high at 10,725. Technical analysts that I read overnight were saying that the market was getting to a crucial test of the January high, but as long as the index closed above that level, investors were looking at a relatively minor correction in a trend that still pointed upwards.

But the gradual decline on Thursday, May 6th, gradually took the index closer and closer to that key test at 10,725. At 1:38 p.m. ET the Dow broke below the January 19th high, and the selling began to accelerate. By 2:30 the index was down to 10,596.

And then all hell broke loose.

Selling fed on selling and by 2:46 p.m.—that’s just a little over an hour after the index broke below the January 19 high of 10725—the Dow Industrials were down to 9,873.

Last night, technical analysts had been pointing to the February 8th low at 9,908 as the next test below the January high. Well, the index did get slightly below the February low—by 35 points, to 9873—but that marked the end of the free fall and the beginning of a rally that took the index back to a loss of around 350 points by 4:00 PM.

Technical markers taketh away and then they giveth. At least for a few hours today.

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