Severely Oversold Stock Market Offers Up A Rally...

By: Jack_Steiman

The market gapped down big again this morning and the bears tried to follow through on the break below the 200-day exponential moving averages that went away at the close yesterday. They felt sure they had the bulls buried and who could blame them for feeling good about things. However, I sent out an early note telling everyone not to short the move lower as the market was extremely oversold and that shorting wouldn't bring about much satisfaction.

The market blasted higher off the lows with the Dow going green by about 130 points only to see the entire gains wiped out with thirty minutes left in the trading day. It seemed hopeless but, out of nowhere, the bulls took the market up furiously in the last fifteen minutes allowing the market to close near the highs for the day. The bounce we thought would take place did and it should not be over yet.

There should be room back to at least the 200-day exponential moving average on the S&P 500 at 1102 and then after a pause there it should try to move up to its 20 day falling exponential moving average where it should top on this bounce. That would form a right shoulder in a head-and-shoulders pattern but more on that later. Bottom line is, the extreme levels of oversold kicked in today allowing for the start of what should be a decent rally before it ends.

A chart was sent out today showing the potential for a big picture head-and-shoulders pattern that still needs a right shoulder to form, which would also allow for oversold oscillators to unwind back up. The daily charts have MACD's that are simply too compressed down with RSI's near 30. Not the formula for additional downside action. A relief rally should take place that sets the right shoulder, and right shoulders should always have lower right sides than the left.

The 20-day exponential moving average is racing down and should be near 1130 some time later next week. I would think the S&P 500 has a shot at that level although getting through those 200's won't be easy since the SPDR S&P 500 (SPY) also has a gap at 1100 which will make for a strong resistance zone. I think the bulls can ultimately get through this level and get to the 20's I just spoke of and that would set the pattern for a move back lower. There is a shot that the 1100 level will be too tough for the bulls in the end but my gut tells me rally up to the 20-day exponential moving average is in store for this market.

If you're a bull, here's the scenario you're hoping for medium-term. We get the rally and stall at the 200's or the 20's and turn back down. As we go down in price the MACD's hold up extremely well and put in strong positive divergences at the bottom of its cycle range, and thus the market finds a way to bottom without getting in to a deep bear market. Lower price and a higher MACD near the bottom would be great news for the bulls.

Conversely, if you're a bear, you want to see the MACD do next to nothing on this move up and thus make a new low as the market heads back down after this rally concludes. There is no humanly possible way to know how well the MACD will impulse or not on this move so we will have to be spectators to it all. The market will tell us when the time comes.

Today was nice but not unexpected at all. This is still a broken market so don't get excited about anything that took place with today's action. Many leading stocks are in deep bear markets but extremely oversold so you have to expect a rally. Even with today's rally and with higher prices still to come short-term, they will still be in their own bear markets as they trade below their 200-day exponential moving averages. Hopefully they can repair themselves over time but for now and on any rally short-term, that won't help them get out of the poor patterns they are in currently.

Emotions are running high now as bad news continues to come out of Europe and out of our own country. Bail outs, higher taxes, etc, are on everyone's mind. Can you imagine what that does for the sentiment of a market place. It ratchets down the optimism and creates fear and that's exactly what this market needs if it's to have any chance of recovering from the pattern that's currently setting up on the S&P500. With the Volatility S&P 500 Index (^VIX) being so high we are seeing tremendous whipsaw. This is what creates intense emotional reactions from traders.

Breathe and recognize what's taking place day to day. The market is hanging by a thread and should try for higher short-term before rolling over again. It's really what happens on the next down swoosh that'll tell us more about whether this is the start of a bear or if it was just a correction within an ongoing cyclical bull market.

Peace,

Jack

Jack Steiman is author of SwingTradeOnline.com ( www.swingtradeonline.com ). Former columnist for TheStreet.com, Jack is renowned for calling major shifts in the market, including the market bottom in mid-2002 and the market top in October 2007.

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