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After A Classic Oversold Bounce – What’s Next ?

Posted by on Sep 1, 2015

After A Classic Oversold Bounce – What’s Next ?

The stock market was able to absorb several waves of selling on Monday as the Dow Industrials and S&P 500 closed above the day’s lows. The Dow Utilities were the big loser dropping 1.78% followed by a 1.26% drop in the Nasdaq 100.

However the recent bargain hunting has not altered the technical outlook as the rebound from the August 24th lows had all the signs of a classic oversold bounce. The heavy selling in the overseas markets Tuesday has pushed the futures almost 2% lower just a few hours before the opening as the S&P futures are over 40 points lower.

Even with the expected sharply lower opening the major averages will still be above last week’s panic lows. If we get a sharply lower close on Tuesday will that trigger another wave of heavy selling or should investors be ready to endure more choppy high volatility trading before the current correction is finally over.

9-1a

In last week’s market analysis the $197.50 level and the declining 20 day EMA in the Spyder Trust (SPY) were identified as a strong level of resistance.

  • On Friday the high was $199.84 while the 20 day EMA now stands at $201 with the daily starc+ band at $203.85
  • The initial support at $195 is likely to be violated early Tuesday with further support in the $192 area.
  • The daily starc- band is now at $188.66 as the SPY dropped well below this band last week .
  • The S&P 500 A/D line just reached strong trend line resistance, line c, on the rally.
  • The rally has also stalled below the declining WMA with more important resistance at line b.
  • Volume declined last week as prices rallied and the OBV was not able to make it back to its declining WMA.

The SPDR Dow Industrials (DIA) attempted to rebound back to the December 2014 and February 2015 lows in the $167.90 area (line f) before the buying dried up.

  • There is further resistance (line e) and the 20 day EMA in the $169.20 area.
  • From last week’s trading there is initial support now at $157.50-$160 and then stronger in $155 area.
  • The Dow Industrials A/D line peaked in December 2012 and failed to make a new high in April and May.
  • The A/D line formed lower lows in July (line g) and rallied back towards its WMA last week.
  • The daily on-balance-volume (OBV) dropped below important support on August 20th and barely bounced as prices rebounded.
  • The daily OBV pattern still looks very weak and shows no signs yet of a bottom.

What to do? The summer breakdown in the A/D lines and the completion of the rising wedge in the iShares Russell 2000 (IWM) has been sending a strong warning since just before the 4th of July holiday. Until the A/D lines are able to break their downtrends and begin a new rally phase the downtrend in the major averages is likely to continue. This means that it will likely take many more weeks before the market can bottom out.

During the market’s correction in 2011 the initial low in early August was followed by just over two months of choppy sideways trading before the market made its final low in early October. Just five days after this low the A/D lines signaled that the correction was over.

Traders should keep an eye on the S&P futures which have next good support in the 1880-1900 area. A drop to this level could set the stage for another oversold rally. Since the small cap stocks topped out first I am closely watching the iShares Russell 2000 (IWM) and will post a chart of IWM later today onĀ  both Twitter and StockTwits.

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