Not Pretty at All

 | Jul 08, 2014 | 4:24 PM EDT
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The indices were solidly red, breadth was poor and it was a technical-distribution day for the Nasdaq, but stocks did find support around midday and the selling pressure relented a bit. It wasn't pretty but the early worries did subside.

We haven't had three major down days in a row since mid-January, so the bulls are likely to be looking for a bounce to kick in soon. It certainly has not been easy for the bears to gain any substantial downside momentum, but there is still a chance that a change in character is developing. The bulls still aren't very worried but there is good reason for that in view of how often this market comes back from this sort of selling action.

Alcoa (AA) earnings are out and are well ahead. Some will say that bodes well for earnings season, but AA is only important because it is the first earnings report of the season. The real reports are still a week away.

Despite the selling, the market is still in an uptrend but it is under pressure. The Nasdaq has support at the March highs and the S&P 500 and DJIA are acting much as they did during the stealth correction in March and April. The real damage being done is mainly in small-caps and momentum stocks. As we saw earlier in the year, they can continue to fall quite hard, so make sure you stay disciplined.

The market is still technically OK, but issues are developing that require increased vigilance.

Have a good evening. I'll see you tomorrow.

July 08, 2014 | 1:55 PM EDT

Support Finally Kicks In

  • I'm not ready to proclaim that this selloff is over.

While the correction action we are experiencing now can be painful, it is necessary for a healthy market. One of the biggest complaints among market participants is how the market feels artificial and manipulated. The main reason for that is we don't have the natural ups and downs that are a function of ordinary human emotions.

The buy-and-hold bulls celebrate the lopsided action because they are going to be fully invested all the time anyway. The folks who try to play the ups and downs in the market are constantly frustrated by action that doesn't seem to reflect normal human psychology. Sentiment and basic rules of technical analysis (like the importance of volume) have been rendered nearly irrelevant.

The action we are seeing reminds us that fear and greed still matter. In the old days, those emotions gave traders an edge, so it is nice to see them have an impact again, even if it comes with nasty downside action.

We are seeing bounce action now after a poor morning, but the close is what counts. Breadth on the Nasdaq is still poor and the vast majority of momentum names are in the red, but support is finally kicking in. The bulls will be looking for a quick and easy recovery, but I'm not ready to proclaim that this selloff has ended.

July 08, 2014 | 10:18 AM EDT

The Bears Are Pressing

  • There's no choice but to play some defense right now.

Downside follow-through has been a rare thing in this market, but we have a big dose of it this morning.

Momentum stocks are a sea of red, small-caps are down more than 1% again and breadth is better than 2-to-1 negative. Dip buyers are exhibiting no interest in catching the falling knives.

What is most notable is that momentum is working in reverse and is shaking out the bulls, who were becoming a bit too cocky last week. I'm no fan of contrarian sentiment, but the way this market was acting on light volume didn't seem to concern too many folks.

This market has had a tendency to reverse quickly, just as you start to take more aggressive defensive action. There really is no choice but to play some defense when the price action is this poor, but don't be surprised if some of your sales end up not looking all that great. Of course, if this really is the start of something severe, it is very cheap insurance to raise cash and stand aside.

I had a couple stops trigger and my cash level is now quite high. One potential long on my screen is the Direxion Daily Jr. Gold Miners Bull 3x Shares (JNUG). It is a volatile ETF, but it is setting up well. Precious metals are the only group in the green at present.

Be careful out there. The bears are pressing.

July 8, 2014 | 8:33 AM ET

Manage Positions Carefully

  • Caution is warranted, so don't let technical breakdowns build.

You can't win unless you try to win, but you can lose by trying not to lose. --Jack Campbell

The S&P 500 and Dow Jones Industrial Average were down just 0.35% on Monday but, if you looked deeper, there was quite a bit of ugliness. The IWM lost 1.8% which was its worst performance since April 25. The IBD 50 was down 1.6%, and not a single stock on the list managed to close in positive territory.

After the run the market has made since the low in April, the pullback is hardly a blip on the screen, but that doesn't mean that we can completely ignore the poor action. It is still extremely premature, but we do need to contemplate whether this is the start of a topping process.

I'm sure the bulls are scoffing at the notion that the market could see some sort of short-term top. After all, any sort of skepticism has been punished quickly as the market rapidly turns back up and traps the overly anticipatory bears.

My advice has been to not even think about a market top until there is some negative price action. Even that has been proven to be overly pessimistic. Twice in the last month, we have seen one-day pullbacks in the S&P 500 -- but each was totally forgotten within 24 hours.

Nonetheless, after a day of selling (like we saw yesterday) some increased caution is warranted. The big danger is that this is a prelude to the same sort of action that we saw in late March, which, led to a very ugly correction in momentum and small-cap stocks. The correction was completely hidden by the defensive names in the senior indices but under the surface it was brutal, much like it was yesterday.

The idea isn't to rush out and sell everything just because of one poor day. However, it is important to watch for signs that some downside momentum is building. The losses can come very quickly in a pullback like this. I know several traders who commented that yesterday was their worst day of the year as they were caught holding large positions in key momentum names.

The big risk is that increased defensiveness will result in being investors being underinvested and cause them to miss out when the market regroups and runs straight back up. That is what has caused so many fund managers to underperform for the last couple years. As soon as they take some action -- just in case the market is finally going to correct a bit -- it turns right around and acts like nothing at all has happened. The bears are squeezed and the underinvested bulls have to chase once again.

Of course, if you aren't a little cautious after taking a hit, there is the risk that this will be the time when the market really does correct in earnest. My belief is that it is better to error on the side of protecting capital but that can be very frustrating in a market that seems to forget its weaknesses so quickly.

At this juncture, the important thing is to manage positions carefully and not let technical breakdowns build. If something doesn't act right, then cut the loss and worry about buying it back later on if you still favor it.

Earnings season starts tonight with Alcoa (AA) but the key reports don't start to roll in until next Tuesday when Intel (INTC) reports. There aren't a lot of news catalysts right now and that is likely to keep the action choppy.

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