Why did the market reverse on Friday? Here’s why…

The broad market began the day with a
strong opening gap up last Friday, but confluence of the Nasdaq
Composite’s primary downtrend line and its 50-day moving average caused stocks
to trend lower throughout the remainder of the session. Within a few minutes of
the market’s opening, the Nasdaq was showing a gain of 1.3%, but the index
finished the day 0.4% lower. The S&P 500
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Average
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0.1%. Both the small-cap Russell 2000
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0.4%. The opening strength caused our short position in the iShares Russell 2000
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lower and could now resume its primary downtrend from here. The iShares Silver
Trust
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show a marked to market gain of nearly 9 points since our August 1 entry.

Total volume in the Nasdaq increased by 1%, but volume in the
NYSE was 5% below the previous day’s level. The loss on higher volume
technically caused the Nasdaq to register another bearish "distribution day,"
but the percentage increase in the Nasdaq was inconsequential. Further, turnover
in both exchanges came in below their 50-day average levels. August is typically
a month in which many traders and investors take a vacation, so it is common to
see a decline in both volume and volatility during this time of the year.

Perhaps the biggest factor that caused the market to reverse
its gains last Friday morning was the convergence of resistance on the Nasdaq
Composite. Not only did the Nasdaq run into resistance of its 3-month downtrend
line, but it also failed to break out above its 50-day moving average. We have
circled this multiple area of resistance on the daily chart of the Nasdaq below:

Initially, it looked as if the S&P 500 was finally going to
break out and close above its 1,280 resistance level, but the Nasdaq’s weakness
acted as an anchor on the other indices. This resulted in bearish candlestick
pattern being created on the daily chart of the S&P 500. The long "wick" or
"tail" on Friday’s candlestick has created overhead supply from the bulls who
bought the gap up in anticipation of further gains. Therefore, it will now take
a lot more work for the S&P to get back above last Friday’s high. We circled
this bearish pattern on the chart below:

The S&P’s third failed breakout attempt at the 1,280 level,
combined with the Nasdaq’s bearish reversal at its resistance, does not bode
well for the market. However, the one positive is that the Semiconductor Index
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closed last week above its August 3 low. This means the $SOX is still above
prior resistance of its downtrend line, which should now act as the new support
level. Remember that the overall broad market tends to follow the $SOX, so watch
that index closely in the coming week. If the $SOX blows off last Friday’s
weakness and quickly regains strength, it would mandate a bit of caution on the
short side of the market, at least in the near-term. But until then, we must
assume that the primary downtrends in the major indices remain intact. If long,
stay focused on the Pharmaceutical Sector
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showing great relative strength. The DJ Utilities Index ($DJU) is consolidating
at its high as well. On the short side, just about every other industry sector
provides a positive risk/reward ratio for short selling. As always, be sure to
trade what you see, not what you think!

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