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Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Principles of Technical Analysis: Making Sense of "Flash Crash Thursday"

On Thursday May 6th, apparently some unnamed trader was multi-tasking and mistakenly entered "billion" instead of "million." A few minutes later the Dow was off a whisker less than 1,000 points and Procter and Gamble (NYSE: PG) had lost about a third or $60 billion (yes, billion) of its $175 billion market cap.

By day's end, the markets stormed back, but clearly not all the way back. So what do the charts say about such an anomaly?

On the weekly chart, the major uptrend line from the March 2009 broke.


 

The index also fell below the 10- and 30-week moving averages. The S&P closed the week at 1110.87, just nine points below the intersection of the rising 30-week moving average. This usually indicates a forthcoming bear market, but the extreme circumstances during the week very likely negate this.

The week following the "Flash Crash" revealed deeply oversold levels on the daily chart preempting a possible rebound. My experience also says that when prices decline below a rising 30-week moving average, a snapback rally often occurs. A "V" shape top is far less frequent than a double top. In other words, another peak is not out of the question at this point.

The following week, the S&P remained within the lower Bollinger Band®  near 1050. Above that, the 200-day moving average at 1095 is very near Friday's close.

The indicators were bearish. MACD gave a sell signal. The MACD histogram began a descent into negative territory. The major RSI uptrend has broken. RSI has fallen below the key 50 level. Similarly, stochastics gave a tentative sell signal.  This signal most significant when both %K and %D drop below 80.

The intermediate uptrend line from the February low broke. The following week, an accelerated downtrend formed with four large red candles in a row, showing relentless selling after the uptrend line broke. Also, note that Friday's volume was almost as high as Thursday's.


 

The index fell below the rising 50- and 200-day moving averages, piercing the lower Bollinger Band. At that point, the index was riding the band down, a very bearish phenomenon.

Stochastics, near oversold levels -- with both %K and %D around 27 -- was giving a weak buy signal. But given the selling power behind this decline, a complex bottom similar to the one traced out in late January and early February of this year will have to form before the all clear signal can be given.

Technical Analysis Implications

The graphs should cause an analyst to expect very choppy and volatile trading during the following few weeks. The S&P may need to fall further before it successfully rebounds.

In this environment, stops can be easily run and the individual trader whipsawed. However, extreme volatility can help traders separate the strong stocks from the weak. At some point, we will see a rebound in strong, companies like Apple (Nasdaq: AAPL). On the other hand, already weak stocks like Monsanto (NYSE: MON) may fall further.

This article was originally sent to subcribers of Dr. Pasternak's "Double-Digit Trading" service on May 10, 2010. The charts and stocks that are mentioned are used to illustrate how an investor can learn to use technical analysis to identify trends, and they should be used for educational purposes only.

If you want to learn more about using technical analysis in your portfolio, we recommend Principles of Technical Analysis: Double Top Formations Explained and The Six Biggest Mistakes Technical Traders Make.