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By: Chris Rowe — May 24, 2010

These Are the New Key Market Levels to Focus on

First a quick review, and then we'll talk about what's likely to happen next.

Two weeks ago in my article "...Short the Squeeze", when the market rallied off of the "flash crash" low, I told you to sell in to strength and even get bearish. 

In last Tuesday's article (which was written the night before), I told you we would be looking for a confirmation of a bullish reversal pattern: a "doji" (white square below).  The doji came on the same day it completed a typical 50% retracement of the last major move.  On an intraday basis, that level was right above the lowest closing price, and what was then potential support (dotted line).

There were many signs -- besides the doji, the 50% retracement, and the support level -- that perhaps we had seen a short-term bottom. 

But I stressed the importance of confirmation (in the form of a "follow through" day -- a strong up day, preferably with a much higher opening price -- on the following day) before acting on it. 

I said we wouldn't respect the signs of a bullish reversal until the candle pattern was confirmed with an up day.  That obviously didn't happen (red arrow). 

And I'm glad it didn't happen, because now I have a follow up article to write with this real live example of why confirmation is needed.

You don't want to jump the gun on trades, and you don't want to get outright BULLISH just because you see a bearish trend reversing.  If anything, it is typically a good time to reduce bearish exposure ... but NOT to be bullish. 

The following day (red arrow) may have seemed to some people to be just another down day in a handful of ups and downs.  But because we were looking for a confirmation of the bullish doji, the next day's action was CRITICAL.  The fact that it was a down day (non-confirmation) told all the computers that bought stocks when seeing the bullish doji to sell, and certainly to stop buying. 

SO WHAT NOW?

Below is an expanded version of the same chart.  You can see that I circled a candle (a "bullish hammer"), which was another potential reversal day, and it happened right at the potential support level created at the last bottom (dotted line).  That gave us further confirmation that the market wanted to continue a bearish trend.  So now we have to look forward for entry points for bearish positions. 

The key points to focus on are as follows:  (scroll down)

The old potential support level (dotted line) becomes the new potential resistance level. 

So if the market rallies, that would be one place to try to take bearish positions.  It would be even more of a potent resistance level if it coincided with the new down trend line (white diagonal line).  Also keep in mind that the dotted line is right around the same point that would be a 50% retracement of the recent sell off.  A 50% retracement of a move is typical before the main trend (bearish in this case) resumes. 

It's not an exact science, so note that the market can move slightly above both lines and then reverse down.  Everyone will watch closely at that point for signs of strength or continued weakness. 

We'd see strength if we got a strong rally above those lines on heavy volume, but even then, we would look for another pullback to see if the strength is confirmed on a second move higher. 

The solid horizontal line shows the support level created back in February.  The market did bounce off of that level and could do so again.  But if the market closes below that level, you can expect more downside.  

Two weeks ago I told you the market is rallying up to old support and new resistance, and that's the time to get bearish again. 

Same scenario today.  Look for resistance at the key levels above.  As overly simple as it sounds, it doesn't need to be complicated.  Right now we are just looking for entry points in a bearish trend.  That's going to be the best way to play the most favored (not to be confused with favorable) outcome of this market.

I hope this helps.  Please be sure to jump on Thursday's FREE Tycoon Reader Webinar!  See ya then!

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