Trading the stock market pullback

Good day! Since the beginning of August we've been following the development of a "rising wedge" formation in the indices. This began after a strong rally off early July lows was followed by a series of slightly higher highs for a total of three highs. This pattern repeated on a smaller time frame since the start of August, as depicted in the charts of the previous couple of days. A rising wedge is a bearish pattern and it's been forming within a larger weekly trading range in the indices. The light volume that took place as the indices crept higher earlier this month supported underlying weakness in the market. The short strategy triggered going into the evening hours on Monday and the bias confirmed when the lower end of the trading channel on the daily time frame broke in all three of the major indices on Wednesday.

Dow Jones Industrial Average

The economic data didn't hurt the position of the bears. This included the overseas data. Germany and France both reported declines in their industrial production of 0.5% and 1.6% respectively. The data stateside didn't offer the bulls much to be excited about either. Cisco's disappointing earnings following Wednesday's closing bell took the index futures sharply lower afterhours. CSCO beat profit estimates by a penny, but fell short of revenue expectations. Although the index futures recovered most of the afterhours losses by 4:00 a.m. ET, the selling resumed ahead of the open. It increased when initial weekly jobless claims rose unexpectedly last week by 2,000 to 484,000, while in other news, The Labor Department's Bureau of Labor Statistics reported that export prices fell 0.3% in July. Import prices rose 0.2%.

The market hit support going into the opening bell when the Dow struck its 50 day moving average. This was also equal move support on a 5 minute time frame for the early-morning drop as compared to the afterhours breakdown on Wednesday. Extreme gaps in the indices have a strong tendency to fill unless the gap triggers a larger setup, such as on Wednesday. On Thursday, however, the gap was an extension of the larger setup, making it more likely to begin to close early in the session. Although the gap never closed completely, it came close. The market established a series of slightly higher highs throughout the morning, leaving the intraday trend extended on the upside going into mid-day. This created favor for a pullback into the early afternoon. Although the market initially pulled lower out of the 12:00 ET correction period, it was the slower push back into highs at 13:00 ET that led to a stronger afternoon pullback.

S&P 500



I was initially watching for a bear flag to form at 14:00 ET on the 5 minute time frame. The technical action up until that point had been very smooth and easy to read. For a strong bear flag to form, however, the indices needed to hug 14:00 ET support or pull up only slightly off that low into the 5 minute and 15 minute 20 period moving averages with two smaller waves of buying within the correction. Instead, the initial reaction to the support was followed by a push to a slightly lower afternoon low without a secondary pull higher within the congestion. This slightly lower low created a bear trap and the flag failed to develop. The trap returned the indices to the day's highs, but the market still pulled back slightly ahead of the closing bell with all three of the major indices posting a loss on the day.

Nasdaq Composite

The Dow Jones Industrial Average ($DJI) posted a loss of 58.88 points, or 0.57%, and closed at 10,319.95 on Thursday. Just over a third of the Dow's 30 index components managed to come out of the session with a gain. The best performers were Verizon (VZ) (+2.57%), Travelers (TRV) (+1.37%), Pfizer (PFE) (+1.25%), and McDonalds (MCD) (+0.68%). Cisco (CSCO) was the biggest loser, falling 9.99% on disappointing earnings and a downgrade of the semiconductor sector. American Express (AXP) (-1.89%), Caterpillar (CAT) (-1.76%), Hewlett-Packard (HPQ) (-1.55%), and Microsoft (MSFT) (-1.49%) were among the top decliners.

The S&P 500 ($SPX) fell 5.86 points, or 0.54%, and closed at 1,083.61. The top performers in the S&P 500 were Office Depot (ODP) (+4.46%), Motorola (MOT) (+4.16%), Akamai Tech. (AKAM) (+3.63%), Priceline (PCLN) (+3.63%), and MetroPCS (PCS) (+3.53%). Cisco (CSCO) was the S&P's top decliner. It was followed by losses in Netapp Inc. (NTAP) (-8.72%), Juniper Networks (JNPR) (-6.83%), JDS Uniphase (JDSU) (-5.77%), and E M C Corp. (EMC) (-4.93%).

The Nasdaq Composite ($COMPX) ended the session lower by 18.36 points, or 0.83%, on Thursday and it closed at 2,190.27. Priceline (PCLN) was the biggest gainer in the Nasdaq-100, followed by Amgen (AMGN) (+1.97%), Warner Chilcott (WCRX) (+1.77%), and eBay (EBAY) (+1.60%). Cisco (CSCO), Netapp (NTAP), Flextronics (FLEX) (-6.67%), and Altera Corp. (ALTR) (-6.07%) topped the decliners.

Going into the weekend, the indices are at a strong enough level of support to hold intraday. The larger bias remains bearish, but the market is favoring a period of congestion or correction off this zone of support with the 30 minute 20 sma as the strongest level of resistance for the correction prior to a continuation move on the downside. Intraday upside moves should be approached with a scalp or daytrade bias and greater caution used on swingtrades.

Note: Unless otherwise stated, the index action described in this article relates to the E-mini futures contracts for the respective indices. Actual index action may differ slightly in terms of pattern formation, although the market bias will remain the same.

Toni Hansen is president and co-founder of the Bastiat Group, Inc., DBA Trading From Main Street. Toni is one of the most respected technical analysts and traders in the industry. She has been trading and educating new traders, money managers, professional market analysts and traders throughout the boom and bust of the last decade. She has worked in conjunction with some of the world's top financial exchanges. Learn more about Toni Hansen and the educational services she provides through her website at http://www.tonihansen.com.

About the Author
Toni Hansen

Toni Hansen is president and co-founder of the Bastiat Group, Inc., DBA Trading From Main Street. Toni is one of the most respected technical analysts and traders in the industry. She has been trading and educating new traders, money managers, professional market analysts and traders throughout the boom and bust of the last decade. She has worked in conjunction with some of the world's top financial exchanges. Learn more about Toni Hansen and the educational services she provides through her website at http://www.tonihansen.com.

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