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Buying, Selling Exhaustion, or a Correction?

Stocks again sold off on Tuesday, as the recent selling in technology and growth stocks spread to other markets. Dow Jones Industrial Average (INDU) tumbled more than 667 points before closing 473.66 points lower or -1.36%. INDU recorded a gap down (34,672.74-34,741.57) today, its first since the beginning of the year. S&P 500 Index (SPX) also fell 36.33 or -0.87%. SPX also suffered a gap-down today (4,162.04-4,188.13), its second gap in the past week.


The Nasdaq Composite Index (COMPQ) witnessed a sharp decline during the early hours of trading. However, COMPQ escaped a third gap-down in recent weeks. By the end of the day, COMPQ declined 12.43 points or -0.09%. At the lowest point in the morning, COMPQ plummeted to an intraday low of 13,107.70, losing 720.90 points or -5.21% in two days. From the 4/29/21 all-time high (14,211.57), declined 1,103.9 points or -7.77%. The Nasdaq I00 Index (NDX) also avoided a third gap down today, declining -7.81 or falling 0.06% for the day.


Many internal short-term technical indicators are overextended and beginning to tilt toward the bearish side. The sharp selling in the mega-cap technologies and the high-growth stocks over the past couple of days suggests the selling pressures are building. Key indexes, including many in the technology and growth areas, are nearing critical levels.


So, is the recent selling a sign of buying exhaustion, selling exhaustion, or just a correction?


Exhaustion often offers when the stock or index does not have the support from buyers or sellers to continue moving up or down respectively. When this occurs, traders and investors can expect a short-term reversal.


Like weight training or intense exercises, one goes through an exhaustion cycle that starts with high energy and ends with fatigue. Stocks undergo similar cycles. Strong advances follow by fatigue and exhaustion. Signs of fatigue can show up well in advance of sharp sell-offs.


The early warnings are: (1) New highs occur on weak volume creating technical divergences. (2) Closes consistently occurs near the session lows. (3) Weak relative strength readings. (4) Failure to recover after sell-offs or poor recoveries. If the above signs develop, it often serves as an early warning that a stock or index is vulnerable to a sharp downturn. If the above four signals occur, then an impending sell-off will likely occur.


Enclosed below are three major ETFs (SPY, QQQ, and DIA). Focus on the above four technical signs for early indications of sharp downturns. Also, remember the primary trend will determine the intermediate-term directions.


Source: Courtesy of StockCharts.com

Source: Courtesy of StockCharts.com

Source: Courtesy of StockCharts.com

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