Market Nears Confirmed Downtrend Signal

Aug 14, 2007: 6:25 PM CST

The US Equity Market has taken a surprising downturn, and where some are using the word “correction,” other are using the term, “top” indicating their belief that the Dow High of 14,000 was the ‘top’ price of 2007.

Without a doubt, the market is in a much more precarious situation than it was less than a month ago, and support levels – via moving averages – on the weekly charts have been tested and broken, and the daily charts are dangerously close to being classified as beginning a new official downtrend.

Recall that the definition of an uptrend is a series of sequential higher highs and higher lows. By definition, a downtrend would be the reverse of this definition. Where are we now?

The Dow Jones Average – a composite of 30 stocks – has created a pattern of a lower low first, a swing up for the creation of a lower high, and now we are currently trading lower than the prices established by the most recent lower low. Folks, this is about as close as it gets to calling a new downtrend in the market.

Before I classify the market as such, I want to see one of two things happen:

  • The market must break its 200 period moving average on the daily charts (Dow at 12,850)
  • The market must break its 50 period moving average on the weekly charts (Dow at 12,700)

If either of these two things happens, price will have violated many of the major definitions of ‘safety’ and ‘uptrend’ in terms of price swings and distance above key moving averages.

Let’s look at the Dow:

All we have left is the rising 200 period moving average at 12,828 for the final level of potential major support for the market. I’m willing to let price test this level before declaring the market in a confirmed ‘downtrend,’ but that’s only because that level is so close to the current price (only 270 points away – the way volatility has increased recently, that could happen in one or two days).

The only good news that jumps out from the chart is that there is a seemingly positive momentum divergence in the 3/10 oscillator. We’ll see how this plays out.

Also, those that are good at spotting “Measured Moves” can note that the first downswing leg was approximately 700 Dow points in length, and we have just about achieved that with the recent four day decline (from 13,700 to 13,000). Perhaps price will have exhausted its downthrust by the time the 200 period moving average is tested.

I’m honestly concerned and shocked that so many hedge funds are having such significant difficulties in the current environment. Funds that relied strictly on computerized algorithms are having large difficulties and large drawdowns – some funds have closed entirely and other funds are prohibiting clients from withdrawing further money.

Funds use such leverage, and – in a few cases – both sides of leveraged hedged bets are losing the fund money. It’s more than a ‘double-edged sword’ and more than a conundrum. Long-time traders are now stating that the current environment is unlike anything they have seen either in their entire trading careers, or “in a long period of time.”

Please trade safely, meaning pull back any leverage you use if you’re a retail trader and trade to learn and build skills in this difficult environment. Cull your positions to proven setups that work for you and don’t be trying exotic trade setups that you haven’t used before. In this period, fall back to what works, or trade lightly so that your account – and motivation – is not severely damaged in the current environment.

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