Unless you've been living in a cave since yesterday afternoon, you don't need me to tell you the stock market absolutely got slammed yesterday! After the failure of America's oldest investment brokerage firm caused the major indices to open several percent lower, bulls quickly took advantage of the perceived buying opportunity, enabling stocks to recover much of their opening losses. But despite the valiant reversal attempt, the bears resumed control in the afternoon, sending the main stock market indexes below their morning lows. Suffering its worst percentage loss since the first trading day that followed 9/11, the S&P 500 finished with a colossal loss of 4.7%. The Nasdaq Composite fared only slightly better, tumbling 3.6%. The Dow Jones Industrial Average plunged 4.4%. The small-cap Russell 2000 and S&P Midcap 400 indices swooned 4.2% and 4.4% respectively. A brief, late-day rally attempt quickly fizzled out, causing all the major indices to finish at their dead lows of the day.

Not surprisingly, volume levels surged higher, as investors rushed for the exit doors. Total volume in the NYSE swelled 30% above the previous day's level, while volume in the Nasdaq similarly spiked 35% higher. The gigantic losses on sharply higher volume were clearly indicative of institutional selling, though we typically only track the number of "distribution days" the S&P and Nasdaq have registered when the broad market is in an uptrend. Market internals were the most negative I've seen in my ten-year trading career. In both the NYSE and Nasdaq, declining volume annihilated advancing volume by a margin of 20 to 1! In the NYSE, the number of losing issues exceeded advancing issues by a margin of nearly 19 to 1! That ratio was actually worse than the advance/decline ratio of Black Monday, back in October 19, 1987. On Black Monday, when the S&P 500 fell 20.5%, losing stocks outnumbered winning stocks by approximately 16 to 1. Putting the atrocious market internals in perspective, yesterday's percentage losses could have been much worse.

Yesterday's bloodbath caused both the S&P 500 and Dow Jones Industrial Average to finish at fresh 52-week closing lows. The Nasdaq Composite narrowly avoided the same label, as the index held ten points above its March 2008 closing low. The bad news is that stocks, ETFs, and indexes trading at 52-week lows lack any type of significant horizontal price support on their daily charts. The good news, however, is that the S&P 500 is quickly approaching major support on its long-term monthly chart, which is annotated below:



The dashed, ascending line on the chart above marks support of a very long-term uptrend line in the S&P 500, which began with the low of December 1994. In technical analysis, the longer a trendline has been in place, the more likely the dominant trend will remain intact. In this regard, we consider a 14-year old uptrend line to be rather significant. Furthermore, notice how this long-term uptrend line converges with key support of the 50% Fibonacci retracement level (from the October 2002 low to the October 2007 high). Notice how, in January and March of 2008, the S&P 500 bounced after testing support of its 38.2% Fibonacci retracement (circled in pink). As the 50% retracement is even more significant, odds favor a decent countertrend bounce when the S&P 500 first tests its 50% retracement level. Joining forces with its 14-year old uptrend line to provide major price support at the 1,172 level (circled in blue), the 50% Fibonacci retracement is just 1.8% below yesterday's closing price.

If you've been following the overall suggestions of our commentary over the past month, you may have sustained a losing trade or two yesterday, but should have managed to avoid a lot of pain. Since getting stuck in a choppy, sideways trading range in mid-August, we've been advocating cash as the dominant position in your portfolio. After the broad market formed a bullish reversal day on September 11, we said it may be a good time to "dip a toe in the water" on the long side of the market, but we also warned against aggressively getting too heavy on the buy side without first seeing more price confirmation. Fortunately, we heeded that cautionary part of our advice. The two long positions we carried into yesterday's session (IBB and QLD) obviously moved against us, but their losses are still small when compared to the solid gains realized so far this quarter. More importantly, regardless of the result, we had clear, well-defined reasons for entering those positions last week. Even seeing how things played out, we would still make those same trades all over again if given the chance. Whenever we lose money on a trade that was carefully selected through technical analysis, it's always a complete waste of time, energy, and focus to obsess over a negative outcome. This is doubly true when the trade was subjected to a huge news event that was beyond your control.

Now that the S&P and Dow have definitively broken down to new lows, it paves the way for a "capitulation" process to get under way. Further, yesterday's market internals were so utterly bearish that we believe it predicts one of two things: the start of a huge leg down in the market from here or the bottoming process of the current bear market. Of course, it's way too early to know which one of those scenarios is about to take place. Bulls could logically argue that the ultra long-term uptrend line and 50% Fibonacci retracement of the S&P 500 will help to form a significant bottom in the broad market. But just as valid would be an argument by the bears that the short-, intermediate-, and long-term trends will remain intact until the market proves otherwise. As for the impact of the extraordinary financial news events bombarding us every day, we prefer to leave that situation out of our analysis altogether, as the reaction to news events, both large and small, will always show up on the patterns of the charts. One thing that can't be argued is that this is an unprecedented time in recent history of the U.S. stock market. Use extreme caution on both sides of the market, and remember to trade what you see, not what you think!

Open ETF positions:

Long - IBB, QLD
Short - (none)

Deron Wagner is the Founder and Head Trader of both Morpheus Capital LP, a U.S. hedge fund, and Morpheus Trading Group, a trader education firm launched in 2001 that provides daily technical analysis of the leading ETFs and stocks. For a free trial to the full version of The Wagner Daily or to learn about Wagner's other services, visit MorpheusTrading.com or send an e-mail to deron@morpheustrading.com.