Focus Letter

Market Correction Slows

Good morning! The market finally saw some decent action on the upside on Friday for the first time since the recent daily selloff began on May 11th. The 100 day simple moving average in the Dow Jones Industrial Average and 200 day sma in the S&P 500 that we were looking at going into Friday held very well as support and the intraday action panned out right in line with expectations, seeing some continued selling in the morning followed by a move off those lows into the early afternoon. It was the first day in over a week that we began to see a lot of the more textbook intraday patterns finally forming and following through well once again without a lot of choppiness.

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The strongest sectors on Friday were the semiconductors, leading the market with a +3.2% gain, followed by the brokers who put in a +1.5% gain overall. Banks, airlines, and utilities also managed to close higher. Computer-software stocks and residential builders had a slightly more difficult time, posting losses of -0.2% and -0.1%, respectively. Volume was high as the week wound to a close, assisted by options expiration. 2.21 billion shares were traded on the Big Board, with 2.558 billion on the Nasdaq, making it one of the highest volume days of the year. By the close all three indices managed to post small gains. The Dow Jones Ind. Ave. rose 15.77 points (+0.1%), while the S&P 500 gained 5.22 points (+0.4%). The Nasdaq Composite had the largest percentage gain, climbing 13.56 points (+0.6%).

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The morning downside was fairly reserved on Friday morning. The indices opened with a very slight upside gap. They then formed a small bear flag on the 5 minute charts, using the 5 minute 20 sma as resistance. The pace on the upside within the flag was a bit stronger in the S&P 500 and Nasdaq than in the Dow and this made it more difficult for those two to break to significantly lower lows on the 5 minute charts before they began to bounce again.

Once more, the pace off the early morning lows from around 10:15 ET was also near average. This type of action is typical of a trading range and makes significant breakdowns more difficult without pace on the upside being more gradual. The market did slow a bit along support into 11:00 ET and this allowed for a rapid flush to new lows shortly thereafter, but the volume was very high as the indices hit their daily support levels, creating an exhaustion move that allowed for the beginning of a correction heading into the afternoon.

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The market retraced very quickly off the late morning support, rallying into the 5 minute 20 sma within a matter of minutes. This began a change in pace that continued into the 12:00 ET reversal period with a more gradual pullback as compared to that rally on the 5 minute charts. Since this retracement was still more than 50% of the prior rally off morning lows, it took another small bullish continuation pattern into 12:30 for the pace to turn over even more before the market finally broke its intraday downtrend.

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The indices rallied sharply in the early afternoon, forming a bull flag out of the 13:00 ET reversal period on the 5 minute charts before hitting significant resistance on the larger time frames due to the trading range from the prior two days. This hit going into the 14:00 ET reversal period and the market held that level for the remainder of the session, pulling steadily back into the mid-day channel break level of 12:30 ET before bouncing again into the close.

During my weekend scanning, most of the stocks I came across are at significant daily or weekly support levels and are looking to react more to these levels as we head into the new week. Since the pace of the decline in the market overall was so steep, the reaction off the support will often be slower and more choppy. There was a bit of a slow down in the downside pace over the last couple of days, however, so that can help things out a bit more. If the indices do manage to react strongly, I would expect the highs made about two weeks ago to hold and push the market into a longer trading range in the form of a triangle on the weekly charts.

If the market is unable to display a strong reaction off the current lows, then we are more likely to see an Avalanche type of pattern form, whereby a longer trading channel at the daily and weekly support levels would be likely to break lower. This would be most probable if the indices are unable to take back more than half of the losses of the last two weeks over the next two weeks.

Intraday we are still seeing a tendency to revert to strong selling rather quickly. The best intraday buy setups will take place when that selling slows as compared to the intraday rallies. Ideally, volume would also be declining on those pullbacks from highs to show a lack of concern by the bulls and hesitation from recent bears.