Panic Sellers Are Often Sorry

by Tom Aspray

Widespread recent selling in equities and gold looks to be a panic reaction by the masses, as opposed to a calculated response to real market data.

The over 5% decline in the Dow Industrials in the past two days has turned investors’ focus back on the downside, which is different from the positive spin that prevailed just a week ago.

From a technical standpoint, I have been making the case that the rebound from the August lows was a typical flag formation. The Nasdaq Composite has been the strongest since the August lows, but the negative signals from the McClellan Oscillator as of Tuesday’s close indicated even the Nasdaq had likely topped out.

Those who sold at the August 9 lows have had almost two months to watch the market stage a typical 50% rebound. If anyone sold yesterday because stops were hit or as a result of a previously developed plan, that is fine, but Thursday’s drop suggested many were just hitting the sell button in a panic reaction.

The bearish sentiment of individual investors jumped sharply this week, as 48% are now bearish with just 25% bullish. These numbers are as of Wednesday, so they should become more bearish by next week.

Gold was also hit hard Thursday and could be vulnerable to more panic selling before the current correction is over. By looking at the charts, we can get a better idea of what may occur so that you can develop a plan based on data, not emotion.

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Chart Analysis: The daily chart of the Spyder Trust (SPY) shows that it gapped below support on Thursday, line b, completing the flag formation. SPY is now just above the August lows at $110.27, which are likely to be tested over the next week.

• The 127.2% Fibonacci target from the flag formation is at $106.50, while the width of the flag gives downside targets in the $104-$105 area
• The NYSE Advance/Decline (A/D) line broke support, line d, with Wednesday’s close, setting the stage for Thursday’s plunge. The last rally had taken it just barely above its weighted moving average (WMA)
• The A/D line needs to move above its downtrend (line c) to turn positive
• The A/D line shows a band of major support between the March 2011 lows and the November 2010 highs
• Volume had been declining as the flag developed, but broke its downtrend on Thursday’s drop. It is still well below the levels seen in August, so the volume should be watched closely

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The Nasdaq Composite was much stronger than the S&P on the rally, but the PowerShares QQQ Trust (QQQ), which tracks the tech-heavy Nasdaq 100 Index, was even stronger, as it surpassed the 61.8% retracement resistance.

• Thursday’s drop gapped through support at line b, completing the flag formation
• The close was at the daily Starc- band with next support at 2330-2385. The 127.2% target from the flag formation (lines a and b) is in the 2250 area
• As noted Wednesday, the negative divergence in the McClellan Oscillator, line c, indicated the rally was over. It is back to -150 and could fall to the -250 or -300 level before the decline is over
• A rebound over the next week or so is likely to fail near the zero line
• Resistance now stands at the gap in the 2500-2550 area

The SPDR Gold Trust (GLD) dropped 2.6% Thursday on volume of 32 million shares and is down another 2% in early-Friday trading. This will take GLD close to the weekly Starc- band at $163. Over the past month, the closeness to the weekly and monthly Starc+ bands had indicated that risk on the long side was high.

• The break below support at $174.45 last week and the break of the daily uptrend (not shown) this week set the stage for the sharp drop
• The minor 38.2% support is in the $163.40 area with the more important 50% support at $156.70. This is very close to the weekly uptrend, line e
• The major 38.2% support from the 2008 lows and the long-term uptrend (line f) are in the $140 area
• As noted previously, the weekly on-balance volume (OBV) did form a negative divergence at the recent highs (see circle) and is now testing its weighted moving average. A similar divergence in late 2010 led to an eight-week correction
• The daily OBV (not shown) formed a divergence at the highs and is well below its weighted moving average
• There is resistance now at $172.20-$177.40

What It Means: If you look at SPY, a test of the August lows would be a 2% drop from Thursday’s close, while a drop to the 127.2% target at $106.50 would be another 5.6% decline. Of course, I expect that the tech sector will hold above its lows.

If you are still holding weak stocks, decide over the weekend how much more pain you can take and then stick to that plan.

Stops under the August lows for stocks or ETFs are risky, as marginal lows could stop you out before prices reverse. I do expect that prices will be 8%-10% higher in the next two weeks. Further weakness should be an opportunity to buy those cash-heavy, high-dividend stocks that others are dumping.

As for gold, a few weeks ago, it looked like gold could fall instead of rally if stocks dropped, and I recommended hedging long gold positions at that time.

The SPDR Gold Trust (GLD) is likely to reach the first downside target in the $163-$165 area over the next week. A drop to the $153-$155 area is possible before the correction is over, but the long-term volume analysis is still positive, so core holdings should be held.

How to Profit: For those who hedged their long gold positions, I would suggest covering half if GLD drops below $165, as there may be an opportunity to put the hedge back on at higher levels.

On Wednesday, I recommended that traders buy the ProShares Short S&P 500 ETF (SH) at $43.36 or better. Unfortunately, the low was at $43.41, just missing the buy level. The fund closed Thursday at $46.28…ouch! Cancel that order at this time.

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