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Market Shakeout Scenario?

Investment sentiments and technical indicators have turned decisively negative in recent weeks, suggesting the summer-to-fall consolidation may be nearing a critical selling phase, at least from a near-to-medium-term basis.


The question is whether the decline soon leads to a market bottom and the start of a sustainable SPX recovery or the continuation of the Jul 2023 decline.


A shakeout is a market condition in which investors suddenly sell their positions simultaneously and at a loss. A market shakeout often occurs because of economic uncertainties, geopolitical events, or bad news (i.e., Fed policy moves, interest rates, inflation, recession, or geopolitical situations such as the escalation of the Israel/Hamas Middle-East conflict).


The shakeout phenomenon results in undercutting crucial technical support or market psychological thresholds. The popular 200-day moving average and the 10% psychological correction are classic supports. A sudden and sharp plunge in the stocks follows the technical breakdown, which results in panic-type selling among inexperienced investors or weak hands, followed by an equally quick recovery as experienced or professional investors (strong hands) move in to buy stocks.

The SPX 7/27/23 consolidation of 417.85 points or -9.07% nears the critical phase. Critical support is 4,195-4,236, coinciding with the May 2023 breakout, 10/3/23 low, the 50% retracement from Oct 2022-Jul 2023 rally, and the pivotal 200-day ma.


Will a breakdown here trigger a market shakeout? And where can SPX find support?


The bottom of the Jul 2023 downtrend channel at 4,163 and the 10% psychological threshold at 4,146 offer the next critical support. Also, if wave 5 decline matches wave 1 decline of -271.767 points, this implies a downside to 4,122. The pivotal 61.8% retracement from the Mar 2023-Jul 2023 rally resides at 4,114.


Under strong selling, SPX may overshoot to the downside as the Jun 2023 head/shoulders top neckline breakdown below 4,328-4,335 (9/22/23) renders a downside projection of 4,048, which also matches the Apr/May 2023 lows (4,048-4,049) and the 5/4/23 island reversal low (4,048). Below warns of deep and more extensive SPX correction, possibly to the mid-Oct 2022 reaction low (3,808.86).

On another note, important technical indicators (volume, Bollinger bands, market breadth, RSI, VIX, and % of SPX stocks trading above 50-day and 200-day ma) near critical phases or oversold levels coinciding with washout conditions. Watch for sharp reversals from oversold levels or conditions for signs to indicate the start of an SPX recovery.

The ability of SPX to maintain above pivotal support at 4,050-4,150 (10%-12%) may decide the next SPX rally or correction. If SPX finds a market bottom, this can trigger a 5%-7% bounce toward resistance at 4,400-4,450.


On the other hand, failure to find support may lead to a deep correction of 15-20%. From the Jul 2023 high (4,607.07), this would imply SPX plummeting to a low of 3,700-3,900 (Dec 2002 and Mar 2023 lows), wiping out the entire 2023 rally.


Source: Chart courtesy of StockCharts.com

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