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By: Chris Rowe — October 8, 2013

Technical Tuesday: Crunch Time! Expect Sharp Price Movements

To hear that the S&P 500 is down 11 out of the last 14 days, you would think there's lots of "blood on the streets" (Wall St. term for devastating price declines).  But the index is actually only down less than 4% from its recent high. 

In fact, while the (large-cap) S&P 500 is off the highs it set 3 weeks ago, the major small-cap and mid-cap indices just hit a new high exactly 1 week ago. 

The best strategy is to have both bullish and bearish positions on at the same time.  Why?

We are probably either right at the point where the S&P 500 is about to bottom out and resume its long-term uptrend or, if we see just a little bit more downside, we will probably decline another 6%. 

S&P 500 1-Year Chart

I'll explain...

In a market like this, it's especially important to avoid being biased!  Consider both bullish and bearish arguments, because you'll probably see a sharp move very soon (but it's hard to say in which direction).

Markets can still decline pretty substantially from here, because behind the scenes they're "weak in the knees".   More and more stocks have been breaking below key support levels, clearing a path for more downside before hitting their next key support levels (lower price levels). 

However, the expectation is that congress gets its act together and "turns the government back on", thus causing prices to advance again.  But keep an open mind that perhaps that is just a short-term upside blip before more downside.  We won't know what the REASON for the downside is until it's already happened.  What's important to remember is that the market is on its heels and the bear is swinging its fists.   

A positive event out of Washington can certainly cause some short covering (buying back short shares which would push prices higher).  In fact, to stick with the bullish argument, don't forget that we are going into what's typically the strongest few months of the year (November - January).

At the same time, consider that (ignoring the potential set up of the bearish chart formation "the rising wedge") the major indices are sitting right on their major uptrend lines (where they usually find support and resume their uptrend).  You can see this by scrolling back up to view the S&P 500 chart.

Also consider what we are seeing in "the fear gauge".  The "VIX" advances with bearish market sentiment and declines with bullish market sentiment.  In the 3.5-year chart, below, you can see it has advanced to a point where it has typically found a top over the last couple of years.  That implies that the bearishness (selling) is nearing an end. 

VIX 3.5-Year Chart

Having said that, markets are "weak in the knees" and still overbought.  In an article I wrote two weeks ago, I discussed the "rising wedge" chart formation which is a bearish chart formation that appears at bull market tops.  Click to check out the article or take a glance at the S&P 500 chart at the top of this one. 

We are at a key support level.  But if that level is broken, consider what is happening right now and then what that implies for future prices.  What's happening right now is institutions are quietly scooping up shares of their favorite stocks or else buying big groups of stocks (like the entire S&P 500).  They are loading up in anticipation of a bullish reversal.  But if prices slice below the current levels, that could cause a major unwind.  All those computers that automatically started buying the market, because of what the S&P 500 and what the VIX are currently doing, would automatically SELL stocks to limit losses. 

And because the latest trend has been more and more stocks breaking down below key support levels, it could be a sizable decline, to the tune of 6% (the blue horizontal line in the S&P chart, above). 

Because we don't know for sure what will happen, it's best to take bearish positions on the weakest sectors and stocks (by selling them short or buying in-the-money put options that don't expire for another 3-5 months) while also taking bullish positions on the strongest performing sectors and stocks. 

For more information on how to do this properly, you can follow this link to an article I wrote in July which also has another link in it to an article I wrote in June on the same topic. 

Sorry I couldn't give you the specific direction to position yourself to profit from.  We aren't the mainstream financial media competing for ad dollars here.  We are just honest and this is what I'm seeing and this is the best way to play it. 

See you next Tuesday.

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