Market Breaks Down But a Rebound Could Be Ahead

On April 25, in the midst of a seemingly complacent bull market, I suggested that the VIX volatility index was flashing a large warning sign and that a high-volatility correction was coming. That, of course, is exactly what transpired.

Now that the S&P 500 (SPX) has declined from its April 26 high of 1,219 to an intraday low of 1,040, below the February low of 1,044, various other technical alarm bells have also been triggered.

The negative alarms are numerous:

• The SPX (a proxy for the U.S. market) has blown through the short-term 20-day moving average of 1,140, the 50-day moving average of 1,167 and the 200-day moving average of 1,103. The SPX has broken below the "flash crash" May 6 low of 1,065.

• The SPX has broken below its 2009 closing price of 1,115.

Taken together, these breaks below key technical support levels are the classic definition of a market breakdown.

But since nothing goes up or down in a straight line, we should also be alert for any technical evidence that the market may be oversold and thus may be setting up for a significant rebound.

Yes, the news is dreary and on several points getting worse. Nonetheless, the technical analyst ignores the headlines and focuses on the chart action.

If we do this, we find some technical reasons to expect a bounce off the 1,040-1,050 level, and a return to at least the 1,100 mark.

Why?

There is a confluence of support in the SPX chart around the 1,000 to 1,054 level, right where the market is chopping now.

Not only is 1,000 a key psychological barrier-market players are drawn to round numbers, regardless of other factors-but the key 38.2% Fibonacci retracement line rests at 1,008.

The key Fibonacci ratios are 23.6%, 38.2%, 50%, 61.8% and 100%.

The February low of 1,044 is close to the "flash crash" low of 1,065, and the long-term 50-day moving average rests right between those support levels at 1,054.

Those lines offer multiple sources of technical support.

I've drawn all these levels on a chart for visual reference.

Since price generally respects key areas of support and resistance, technical analysts expect the market to bounce off key support levels and then rise to key resistance levels, which often act as "ceilings" which must be broken through to advance the technical case for a bullish trend.

Right now the short-term 200-day moving average at 1,103 beckons, as does the 20-day moving average at 1,140 and the 50-day MA at 1,167.

Even if the market has hit its highs for the year, it can be expected to rebound, just as it could be expected to dip down during its year-long advance off the March 6, 2009 low of 667.

Technically, a strong case can be made for the market to find support at current levels (the SPX at around 1,054 intraday) and then bounce about 100 points to the 1,140 to 1,160 level.

Longer term, we shall have to wait to see if the market can break above the resistance offered by the 50-day moving average at 1,167. Were it to do so decisively, that would be a positive omen that the correction has run its course.

Failure to stay above the 50-day moving average would signal further weakness ahead.