Long? Honor your stops

The S&P 500’s inability to rally
above its 1,295 resistance level finally caused the bulls to run for shelter
Tuesday, while the downside momentum attracted the bears as well. The
Nasdaq Composite
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PowerRating) fell 1.1%, the S&P 500 1.0%, and the Dow Jones
Industrial Average
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PowerRating) 0.9%. Small and mid-cap stocks equally felt the
pain, as the Russell 2000
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PowerRating) lost 1.4% and the S&P Midcap 400 dropped
1.1%. The broad market’s losses fully came in the first two hours of trading, at
which point stocks subsequently consolidated in a narrow, choppy range near
their lows. Each of the major indices finished near their intraday lows as well.

For the first time in seven days, turnover in both exchanges
rose above average levels. Total volume in the NYSE increased by 23%, while
volume in the Nasdaq spiked 24% higher than the previous day’s level. The
substantial losses on firmly higher volume made yesterday a clear "distribution
day." Overly bearish market internals confirmed the return of institutional
selling activity as well. In the NYSE, declining volume exceeded advancing
volume by a whopping ratio of nearly 5 to 1! The ratio in the Nasdaq was
negative by "only" 5 to 2.

Although we stopped out of our MDY short position only the day
before, we promptly shorted SPY when it broke support of its hourly uptrend line
yesterday morning. When you stop out of a trade, you cannot be afraid to
re-enter the same or a similar trade the very next day if the setup still
remains valid. As discussed yesterday, we anticipated that stocks would fall
rapidly if the S&P did not break out above resistance of its prior high within
the next day or two. Apparently, we didn’t have to even wait that long. Each
failed attempt to breakout above the 1,295 resistance level weakened the resolve
of the bulls until the overall level of supply finally surpassed demand. The
resulting imbalance attracted more short sellers who, in turn, accelerated the
decline.

Even though we have only seen a one-day decline, we feel that
yesterday’s action caused significant psychological damage to the sentiment of
traders and investors. Not only did the S&P sell off sharply at a key resistance
level, but the Nasdaq Composite fell back below resistance of its prior
downtrend line after trading above it for only one day. Looking forward, it will
be important to see how the major indices hold up as they test support of their
20 and 50-day moving averages over the next several days. On the S&P 500,
support of the 20-day MA is at 1,276, only four points below yesterday’s close,
while the 50-day MA rests at 1,274. On the Nasdaq, support of the 20-MA is at
2,275 and the 50-MA is at 2,271. We have circled support of these moving
averages on the charts of the S&P and Nasdaq below:

Being that the major indices are still above their major
moving averages, it is certainly too early to declare a new downtrend has begun.
However, we don’t see much reason to be long (at least in the short-term)
unless the major indices were to suddenly rally back above their February 27
highs. If you are still long, be sure to honor your original protective stops
without further analysis. This is not the time to be in "hope" mode, hoping that
your stocks will come back to the price you bought them.