Thursday, January 15, 2015
Things might be about to get ugly for bullish stock traders...
Yesterday, the stock market closed right on a critical short-term support level. Stocks need to bounce from here immediately... otherwise, we'll likely see a quick move to the downside.
Let me explain...
For the past few months, the S&P 500 has been trading in a bearish rising-wedge pattern. In this pattern, an index makes consistently higher highs and higher lows but the distance between each new high and low is smaller. Eventually, the index has to break out of the pattern one way or another. When that happens, it usually results in a big move.
After yesterday's pullback, the index is on the verge of breaking the wedge to the downside.
The S&P 500 needs to recover and take back at least half of yesterday's loss or it runs the risk of making a decisive break below the 2,008 support level. That's where the blue support line of the wedge and the red support line connecting the September highs come together. A close below that level will likely lead to more selling pressure and at least a test of the December low at 1,972. The index could even decline toward the October low at 1,875.
You see, as I told you in October, typical market corrections unfold in either three or five distinct legs.
The first move shakes up folks, gets the bears all loaded up with short positions, and shifts sentiment rapidly from bullish to bearish. That was the decline we saw in early October.
The next leg is an oversold bounce. This move forces short sells to cover – often at a loss, especially if they got too aggressive and sold short into oversold conditions. The bulls scramble back in, and sentiment shifts rapidly back to bullish. That's what we saw in late October.
The third leg of a correction is a move back down to retest the lows of the first leg. But the S&P 500 never retested its October low. That's still hanging over the market's head. And that's why bulls need the market to hold above the 2,008 support level. If it can't do that, things could get ugly real fast.
Best regards and good trading,
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