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Stocks Hit Inflection Point; Small Caps Under Pressure

David Becker
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Stocks Hit Inflection Point; Small Caps Under Pressure

Most of the major index ETFs broke below their mid September lows with sharp declines last week, but the Dow Diamonds (DIA) and the Nasdaq 100 ETF (QQQ) held these lows and show relative strength. The Dow is a mixed bag of large-cap stocks, while the Nasdaq 100 represents large-cap tech stocks. These two groups represent the last bastions of strength in September. Breakdowns in both would suggest that selling pressure is expanding and this would be negative for the broader market.

The QQQ is once again trying to hold support with an open below 98 and a move above 98.5 intraday. A close below the September lows would break short-term support and suggest that selling pressure is spreading to large-cap techs.

There continues to be relative weakness in small-caps using the Russell 2000 iShares and the S&P SmallCap iShares. The IWN shows a big head-and-shoulders pattern over the last seven months. With a decline to the neckline support zone, the ETF is testing a major support level that holds the key to this pattern. A break would confirm the reversal and target a move to the 84-85 area, which marks a 10% decline from neckline support.

A bearish head-and-shoulders pattern should show some signs of distribution because this is what happens when a top forms. Distribution occurs when the so-called smart money quietly sells shares to the not-so-smart money. Chartists can measure distribution by using the various volume indicators including the On Balance Volume (OBV). This indicator adds volume on up days and subtracts volume on down days. The theory is that volume precedes price and a break down in OBV would suggest distribution. Momentum continues to be negative with the MACD (moving average convergence divergence) index printing in negative territory with a downward sloping trajectory.

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