Technically, the Charts are Broken

Last week, the S&P500 slid 1.3% on moderate volume.  The VIX (or fear) index rose about 5% for the week, adding validity to the price decline. 

The economic news was mostly negative.  Although consumer credit rose more than expected, all of the rise (and then some) happened only because of a huge spike in Federally backed student debt; without this change in student loans, consumer credit would have plunged.  International trade results were horrible;  the trade deficit was much worse than expected.  Initial jobless claims soared back to almost 400,000–also far worse than expected.  Retail sales met expectations, but only because prices (think gasoline) shot higher; real sales were poor.  Finally, consumer sentiment plummeted, when it was expected to dip only slightly.

Last week was a bad one for the Federal Reserve–the forces for lower stock price overcame the Fed’s best efforts to keep prices going higher.

The technical implications though are important.  Since September 2010, the S&P500 has closed each trading day well above its 50 day moving average (dma).  And in the world of technical analysis, whenever the stock market closes above the 50 dma, many traders and investors gain greater confidence in putting more money to work buying stocks.

Last week, for the first time in over six months, the 50 dma was broken–and not just on the S&P500 charts, but also on the Dow, the Nasdaq and the Russell 2000. 

Why is this important?

Because the same traders and investors who put money to work on the basis of the 50 dma being intact will now be more apt to reverse this decision.   This means that many stock market participants will move up stops and become very aggressive sellers should the stock market continue to fall further.

They’re naturally trying to protect their six month gains, and technically, they’re assuming that other traders will also look at the break in the 50 dma and become trigger-happy sellers.  These traders are staring intently at the exit doors and will stampede through the door at the next sign of trouble.

The first sign has already flashed–the violation of the 50 dma.  To many traders, the stock market charts are now broken.  They’re on stand-by.

If they see any more signs that the house is actually on fire, the markets could easily see a replay of the fireworks last seen on May 6, 2010…..a flash crash.

Given how over-bought and over-stretched the stock markets have become, things could get really ugly, really fast.


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