BROAD DECLINE ROCKS WALL STREET -- FINANCIALS LEAD THE WAY LOWER -- BEAR MAREKT RALLY STILL POSSIBLE -- 200-DAY MOVING AVERAGE MARKS RESISTANCE -- USING RETRACEMENTS FOR TARGETS -- RSI IN A LONG-TERM DOWNTREND

BROAD SELLING PRESSURE HITS WALL STREET ... Today's Market Message was written by Arthur Hill. John Murphy will return tomorrow. - Editor

After moving sharply higher the last six days, the market took a big breather with a sharp decline on Wednesday. Selling pressure started with a gap down on the open and continued throughout the day as the major indices finished near their lows. The Dow, S&P 500, Russell 2000 and Nasdaq each lost over 5%. Chart 1 shows the Nasdaq gapping up on Tuesday, gapping down on Wednesday and filling Tuesday's gap with Wednesday's decline. Tuesday's failed gap and Wednesday's open gap are bearish.

Chart 1

NASDAQ AND NY COMPOSITE HIT RESISTANCE... Chart 2 shows the Nasdaq meeting resistance around 1800 with a long red candlestick. The index surged around 300 points the prior six days and became short-term overbought. Notice that this surge started on above-average volume, but volume declined as the index moved higher. Looks like the advance simply ran out of steam. On a potentially positive note, Nasdaq volume was just average on today's big decline.

Chart 2

Chart 3 shows the NY Composite with the same indicators. This broad index surged over 1000 points the prior six days (~20%) and met resistance around 6300 with a long red candlestick today. A 20% advance in six days is mighty steep. This also created short-term overbought conditions that needed to be relieved. We do not always need momentum oscillators to identify overbought or oversold conditions. As with the Nasdaq, the NY Composite advance started with a surge in volume, but volume declined as the advance extended. Even though today's volume was slightly above average, it was below Tuesday's level and relatively low.

Chart 3

FINANCIALS REMAIN FRAGILE... All sectors were down on Wednesday with the Financials SPDR (XLF) leading the way lower. Chart 4 shows XLF falling over 8% with a long red candlestick. While such a sharp decline is definitely negative, the ETF remains well above its October lows. These lows mark a support zone around 13. XLF formed a higher low in late October and now a lower high in early November. Connecting the dots reveals a potential triangle pattern unfolding over the last four weeks. Chart 5 shows XLF with weekly prices and a clear long-term downtrend. RSI moved below 30 (oversold) at least four times over the last 18 months. Oversold readings are a sign of weakness, and not necessarily a buying opportunity. RSI met resistance around 50 after each bounce and momentum should be considered bearish as long as RSI holds resistance.

Chart 4

Chart 5

TARGETS FOR A BEAR MARKET RALLY... Even with today's decline, the S&P 500 is up substantially over the last seven days and a bear market rally could still be underway. In addition to the October reversal, the market is entering a favorable seasonal period from November to May. In his Market Message on 3 October, John Murphy reminded us of the Stock Traders Almanac, which identifies November to May period as the best six months for the market. With the S&P 500 up substantially over the last seven days, I looked at the last bear market for clues on how far a bear market rally might extend. For this exercise I will use three different technical analysis techniques.

A RETURN TO THE 200-DAY ... Chart 6 shows the S&P 500 with the 200-day moving average during the prior bear market. The index met resistance below or at the falling 200-day moving average at least six times. Chart 7 shows the current S&P 500 with the 200-day moving average. First, notice that the 200-day moving average is falling. This is basically a slow downtrend. Second, the index met resistance at the 200-day moving average in May 2008. The blue dotted line estimates the future trajectory of the 200-day moving average and marks resistance around 1170 at the end of the year. That seems a big high, but anything is possible.

Chart 6

Chart 7

FIBONACCI RETRACEMENT TARGETS... For some more target practice, I am looking at prior retracements with the ZigZag overlay. Chart 8 shows the S&P 500 during the prior bear market with the ZigZag set at 10%. Note that I am using the ZigZag with retracements. The solid pink lines show declines greater than 10%. The dotted pink lines at the top show the amount of the retracements (.502, .596 and .440). After the first decline (1), the subsequent bear market rally retraced .502 or 50% of the move. Chart 9 focuses on the three retracements ranging from 44% to 60%. These numbers jibe with the Fibonacci Retracements Tool, which is shown on Chart 10. A 38.2-61.8% retracement of the May-October decline would extend to the 1100-1200 region (yellow area).

Chart 8

Chart 9

Chart 10

RSI RESISTANCE... Chart 11 shows the prior bear market with weekly closing prices and 14-period RSI. The indicator moved to oversold levels four times with the fourth marking the final bottom in October 2002. There were two big bounces in 2001 as RSI met resistance in the 50-60 zone. Fifty (50) marks the centerline for RSI, which fluctuates between zero and a hundred. The cup is half full when RSI is above 50 and half empty when RSI is below 50. Bear market rallies are expected to hit resistance near this centerline. When RSI reaches the 50-60 zone, a bear market rally is likely closer to its end than its beginning. Chart 12 shows the current S&P 500 chart with RSI. After becoming oversold from late September to mid October, RSI surged back above 30 over the last few days. Even though the surge looks impressive, RSI is expected to meet resistance in the yellow zone (50-60) because this is viewed as a bear market rally.

Chart 11

Chart 12