End in sight of the bloodletting?

Commentary: The stock market finally moved out of the trading range it has been bound to for several weeks, and unfortunately for bulls, the move was to the downside. The Federal Reserve’s “Operation Twist” statement was met with bold selling that took the market down decisively on high volume. The majority of the indexes are now back to their recent lows and are threatening to begin a new leg down. All is not lost yet, however, as the indexes cling on a sliver of support near these lows.

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The S&P 500 as represented by the S&P 500 SPDRS (NYSE:SPY) for instance, didn’t quite reach its August lows on the collapse earlier this week despite falling out of the well defined channel it has been following. While there is an outside chance that SPY can hold this level of support, the odds would favor further deterioration. The financials are already at new lows and could weigh down on SPY over the next few days. All eyes will be on the August lows of course, and it could actually act as a magnet in the coming days. There are many possible scenarios that could unfold here, so traders should remain very careful. (For more, see Channeling: Charting A Path To Success.)

The Diamonds Trust, Series 1 (NYSE:DIA) ETF also broke down from the channel it has been trading in. DIA also fell under its September lows, ruling out that level as a key pivot low. Much like SPY, it appears that a test of the August lows is forthcoming with many possibilities resulting from it. The gap above only further complicates matters as it could act as both a magnet and stiff resistance. The one near certainty is that there will be an increase in volatility when DIA moves in either direction.

While the Powershares QQQ ETF (Nasdaq:QQQ) ETF suffered alongside its peers this week, the action has to be considered much better. QQQ actually held within the wedge it has been trading in and closed out the week on a positive note. The situation is far from rosy, however, as QQQ is dealing with a significant overhead gap and could also break down under its recent consolidation. The rest of the markets look very weak, so it will be difficult for QQQ to operate independently much longer.

The small caps as represented by the iShares Russell 2000 Index (NYSE:IWM) ETF actually set nominally lower lows this week on the heels of the Federal Reserve statement. While IWM reversed from these lows, it is in a precarious position right now as it hovers near the bottom of its trading range. IWM has been lagging for several weeks and could end up leading the markets lower. Traders should keep an eye on the index next week to see if it acts ahead of its peers.

The Bottom Line
The market is in a very dangerous position right now and traders should be looking to protect their capital rather than gaming a bottom. The first group of dip buyers has stepped in and helped pause the decline, but there are still very good odds that the markets will probe new lows. What happens after that will be key as to the state of the market. As mentioned before, there are multiple scenarios that can unfold including a shakeout reversal, a consolidation, or even a full-fledged crash again. Traders should not be in a hurry to place their bets as the market will surely be volatile in most scenarios, and will likely be difficult to trade. Honor your stops and stick to your trading methodology. (For more, see Technical Analysis: Introduction.)

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