The market took a hit on Monday. Heading into the session I had been expecting a pullback off last week's highs due to short setups that had been forming on the 30-minute time frames as I mentioned in the weekend column. These patterns triggered with several strong breakdown setups in afterhours trade. On Sunday the index futures broke lower into 20:00 ET. They then fell into a base until 3:00 am ET Monday when they broke sharply lower once again. Finally, another base or congestion zone from 5:00 am into the open gave way with the opening bell. This confirmed the trigger on the 15- and 30-minute time frames as well as confirming the larger bearish bias. Strong volume on the break lower also benefited the bears.

The indices continued lower in the morning after a brief pause with data at 10:00 ET. April construction spending and the May ISM Manufacturing Business Index came out at that time. Construction spending fell 0.4% in April and March's decline was revised to a 0.6% decline. The Institute of Supply Management reported an increase in manufacturing activity, rising its index level from 48.6 in April to 49.6 in May. Despite the better-than-expected numbers, the market was not able to withstand a larger correction off the support due to the larger technical bias favoring further downside.

Dow Jones Industrial Average ($DJI)


After the breakdown into 10:15 ET, the next correction period was 10:45 ET. The market was coming into support levels at this time from earlier last week and I was beginning to look at potential for a larger correction off the support going into mid-day. To accomplish this we needed to see some rounded lows. The momentum bias remained weak into 11:00 ET and the Nasdaq broke lower at this time. This was also a correction period, so it is a typical time to see such moves.

The momentum began to shift a little after 11:00. The downside slowed and we began to see some rounding off. Volume was light on the upside, however, and this created concern for bulls. The market began to base along the 5-minute 20 sma at noon. This created the start of a potential Phoenix buy setup. Volume dropped off even more, which was a pro for a Phoenix. Standard & Poor's threw a big wrench into the initial attempt by the market to show a correction up off support mid-day. It cut its debt ratings on three of the large brokerages. Lehman Brothers (LEH), Merrill Lynch (MER) and Morgan Stanley (MS) were all hit. LEH lost 8%, while MER fell 2.8%, and MS fell 2.5% on Monday.

S&P 500 ($SPX)


Index prices plummeted following the financial sector assault. This did have the advantage of flushing out the market, however, which created the potential for a correction off lows into the afternoon. The 13:00 ET correction period was the next time level for such a move to begin. Since the momentum was sharp on the downside, it took a bit of time for the indices to begin to move higher. Volume was light as the indices crept into the 15-minute 20 sma even though the sharp volume into the afternoon on the downside was good for exhaustion.

I began to watch for a buy setup late afternoon. The pattern that the market was favoring was a shallow Phoenix. This means it is a Phoenix pattern that comes after a slow ascent off lows, followed by congestion along a 20 sma and then it typically breaks higher with a strong pop when the resistance gives way. It initial began to look like we would see a move out of 15:00 ET, but this proved to be a bit early and the market tried to pull lower off the 15-minute 20 sma. The momentum shifted enough on the smaller tick charts though to still give us that pop into the close going into the final correction period of the day around 15:30 ET.

Nasdaq Composite ($COMPX)


After losing so much ground early on, the late day reversal still left the Dow ($DJI) with triple digit losses. It closed lower by 134.5 points, or 1.06%, at 13,503.82. 28 of its 30 components posted losses, led by the financials. The S&P 500 ($SPX) lost 14.71 points, or 1.05%, to 1,385.67. The Nasdaq Composite ($COMPX) fell 31.13 points., or 1.23%, and closed at 2,491.53.

In terms of the outlook coming out of Monday's action, the daily bias I posted for Monday still rings true: If the indices try to break lower right away early this next week with a lower low on the S&Ps or Dow, then we will be dealing with higher chance the market to bounce again on a larger time frame with more of a 2B type of action (a form of double bottom with a slightly lower second low that creates a trap for the bears). This would be particularly true if it is a slower decline than the ones two weeks ago. Or it could kick off a smaller downtrend, such as the one from 10:30 am to 11:10 am Friday morning on a 5-minute time frame in the ES and YM where the market would be heading into the second wave down.

Since the market did indeed break lower early in the morning on Monday, what we are left waiting to see is whether it breaks last week's lows a bit or holds them in favor of a longer range on the daily time frame. Although the indices hit strong support mid-day on Monday, there is still room to try those lows if the momentum shift from Monday afternoon does not hold. I would actually favor such action for the bulls since it would help round the lows off a bit better once again. The mid-day flush created this added potential.

Toni Hansen is President and Co-founder of the Bastiat Group, Inc., and runs the popular Trading From Main Street. She can be reached at Toni@tradingfrommainstreet.com.