WFC Downgrade Sparks Reversal (by Drew Birenbaum)

Hello fellow Slopers. Some of you may already know me by now, but I wanted to take a brief moment to introduce myself.

My name is Drew Birenbaum and I write a daily technical analysis column at Portfolio Tilt. I am also a full time trader using mainly intraday/short term strategies. I have a strict technical basis for all of my positions, and I typically utilize the most basic technical principles to enter/exit trades. As always, feel free to ask any questions you may have about what I do. Lastly, a big thanks to Tim for giving me the opportunity to connect with an incredibly knowledgeable and respected community! Now, a look at Wednesday's session.

A late day reversal on Wall Street has earned the NASDAQ its third distribution day within this period. In addition, most of the indices printed key bar reversals for the session, an extremely bearish 1-day reversal pattern. Take a look at volume on the SPY during Wednesday's session.

Today's reversal is critical because it signaled a major shift in psychology, and this rapid change in sentiment is what a key bar reversal is all about. I mentioned in the prior update that I had moved to cash due to underlying technical weakness in the major market indices, and that I was also expecting a breakdown in prices. Here is an excerpt from that article explaining the decision:

"At this point, the picture is certainly not as bullish as the day of the breakout gap. Why is that? First off, it is still wise to give the intermediate uptrend the benefit of the doubt until we see a confirmed reversal in price, and this has not yet occurred. As of Tuesday's session, we now have substantially more information about what type of gap we are dealing with, than when the breakout first happened (this is a fairly mundane point). We know that this move has nowhere near the strength of what we saw in July with Intel, where prices exploded higher and began a new intermediate uptrend. We also know that there is a clear sideways rectangle/line pattern forming, and that we are picking up distribution days within this pattern. Given these circumstances, one can make the conjecture that we are dealing with an exhaustion gap, a move that often signals the reversal of the prior trend. This all remains speculation, but I will say that as a precaution, I have moved 100% into cash and will be keeping a close eye on the distribution day count. I will reassess when we exit this neutral range. Below are the 60-minute S&P 500 charts I have been watching."

Looking at an intraday 5-minute chart, we can see the descending triangle that formed over the course of the session. Being aware of the fact that the underlying environment was becoming increasingly bearish, this triangle was an excellent short-term reversal pattern that one could acted on.

Next, we have the usual 60-minute S&P 500 charts. As of lately, I have been discussing the two intermediate targets I set based on simple pattern measuring rules, 1100 and 1130 (I illustrate on the second chart how the measuring rule is actually applied). Today confirms the significance of 1100, and the magnitude and speed with which prices reversed off of this level reinforces its strength. We can see a few things on the second chart that indicated price weakness, before the breakdown actually occurred. The first was the violation of a trend line after the first test of 1100. Following the breakdown, the index made a higher low and rallied back to 1100, piercing through only temporarily before closing lower. Lastly, a triple bearish divergence was formed and confirmed as prices broke through a second redrawn trend line. I find it truly incredible how nearly two weeks of trading can be erased in 60 minutes.

At this juncture, the S&P daily chart is slightly more bullish than the NASDAQ, but that doesn't say much. The S&P has accumulated a total of two distributions days in the recent period, the NASDAQ has three. In addition, the "severity" of the key bar reversal (kbr) on the NASDAQ is greater than the S&P's. Essentially, the S&P 500 reversal was of a lesser magnitude, to explain this technically; the difference between Wednesday's session high and the prior day's high price is greater on the NASDAQ.

I mentioned yesterday that the signs of exhaustion were becoming increasingly more serious. I think that today's reversal all but confirmed the change in psychology needed to spark a pullback. At this point, all I am waiting for is a clear breakout from the neutral range (price confirmation) before I begin laying out some short positions. Remember folks, patience pays off!

Lastly, we have the U.S. Dollar and the Dow Transports. Are we seeing potential signs of a decoupling between the equities and the dollar? This remains to be seen, but it is worth noting that the Dollar closed lower with equities. We also failed to see a Dow Theory confirmation as prices broke away sharply from resistance. We also broke a major primary trend line on very heavy volume.

That is all for now. Thank you for your time Slopers and if you like my work, be sure to follow Portfolio Tilt on Twitter!

NOTE FROM TIM: It looks like the Disqus comments system is having troubles (again). So - - like an awkward breakup - - "it's not you; it's me."