Last week we had two days similar to yesterday, when the Dow dropped over 400 points. Following both of those days, the Dow was then able to rise 400 points. Will the same scenario play out again? Our hunch is that it will not. Our reason is based on the concept of price psychology.
You see last week when the market dipped and then consequently bounced some were left asking “did I just miss the bottom?” After the 400+ point drop on Thursday, those same people likely do not feel that they did. And it is those people who have the power to come in and create the needed demand to firm up prices at current levels, because the people who supported it last week are likely running out of dry powder as the saying goes. And those people probably feel as though they were smart for staying out last week and think prices are likely coming lower.
As a result of their psychology which is based on the price action in the market, the demand they could provide will be absent. This will cause the market to be lacking key support in its current range and will likely lead to an eventual breakdown of 1,120 and retest of 1,100. As we pointed out earlier this week, volume on the way up has been very low, while volume spiked Thursday as prices declined, once again signaling increased distribution.
Especially concerning to us about this most recent plunge is the action in some leading technology stocks. AMZN, CRM, IBM, & BIDU are a few stocks that up until yesterday had still managing to trade above their support bases. However, they have since broken to the downside and are in search new bottoms. Be it that technology was a bright spot for much of 2011, we feel that this could prove ominous for stocks in the days/weeks ahead.
With no major economic reports out Friday our markets will once again be susceptible to the moves in European markets. Watch Thursdays lows closely as a breakdown below them should pave the way for the market to test the low end of last weeks range. As for any bounce the market might attempt, we expect it to run into staunch resistance if it were to rally into the range of Thursday’s gap lower (notice the market respected resistance this week at last weeks gap down range).
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