Invesco QQQ Trust Series 1 (QQQ)

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OT: Breakdown, Bounce and…Confirmation?

Breakdown, Bounce and…Confirmation?

LAST FRIDAY'S ACTION was the trigger that the bears have been waiting to see for weeks. By trading below supports from the recent March-April trading range, the major indexes have given two kinds of bears – the trading bears and the investing bears – reason to rejoice.

The short-termers got a quick ride, the kind they dream about, and from their point of view landed on an obvious (nothing is obvious) place to cash in their short positions.

Many of the indexes, from the Standard & Poor's 500 big caps to the S&P 600 small caps, landed on their respective 200-day moving averages

Clearly, the move down was so swift that it left all sorts of technical momentum-based indicators oversold and the combination left the market in prime condition for a bounce.

That's the old news. As the market works on its recovery and indicators return to more normal readings, we have to look at some of the hiding places ahead where new bears are going to jump on the breakdown and add more supply to the existing abundance of shares now for sale.

In other words, we have to look to see where resistance is going to arise to make an attempt to scuttle the recovery – that is, unless today's inflationary consumer price index report does not do it first.

Technical analysts call this upcoming resistance the "test of the breakdown" since it usually appears at the same level as the breakdown itself. It is where less aggressive bears see their second chance to sell at old prices.

It is also where many bulls trapped in losing positions established by buying at a presumed support level see their chance to get out even or with only minor losses.

All of this selling caps the advance and the market stalls. What happens next is the real key. If the market can absorb all of this selling and actually move higher we'll know right away that the bulls are still there.

We'll know demand for shares is still strong after a minor breather and the breakdown can be deemed false.

But that's where the other type of bears – the investors – come into play. These long-termers enjoyed the short-term trading range breakdown, of course, but also saw a breakdown from a larger trading range that began in November of last year

Further, they have seen the market break below the trendline that supported the cyclical bull market since the March 2003 low and that is a major event in anyone's book.

Whatever short-term upside correction develops here, if any, is of little concern to them unless it not only moves the market back into its old trading ranges but also back above the trendline. It's a tall order, to be sure.

Assuming that the test of the breakdown is successful, we can finally look forward to a market that is trending after months of sideways action.

Unfortunately for most investors, the direction of that trend is down and has the label of cyclical bear market.

The label of cyclical vs. secular bear market has distinction only if you are a long-term investor. During the former, it is theoretically possible to sit tight while the market spends a year or two falling and wait for the next cyclical bull market. But that is highly unpalatable to most people.

A secular bear market, on the other hand, does so much damage and for so long that it may not be possible to recoup losses for many years. Remember, a 50% decline requires a 100% rebound just to break even. It's just simple math.

No matter what we call it, a bear market of any kind means prices are going to go down and that means either selling stocks short or simply stepping aside as the damage unfolds.

The transition period from bull to bear can be immediate, like the March 2000 reversal in the Nasdaq, or it can be gradual, like the year and a half wedge pattern that ended a major bull market for the US Dollar in 2002.

The latter creates plenty of false signals in both directions and frustrates long-term players while giving traders a quick move after quick move to ride.

But when we step back and wait for the market to not only signal the breakdown, as it has done, but confirm it with successful tests, as it looks like it is doing, we'll see a clear trend of lower highs and lower lows emerge. That is how we can be confident that the best course of action is not buying dips but rather selling rallies.