Major Technical Damage Incurred

Yesterday afternoon was a route. Sellers took over with volume and breadth levels that showed an intensity unlike anything we have seen in a long while. Recently we have been maintaining a bullish posture for two primary reasons. First, sentiment readings and the put/call ratio have been overly bearish. Second, the trend was up.

Let's take a look at where things stand after yesterday's onslaught.

Options traders are extremely bearish and have been buying puts furiously. Likewise, the VIX (which measures investor fear) spiked up to levels not seen since the market corrected last February and then rallied on up to fresh new highs. These are two bullish implications.

Nevertheless, there are some bearish implications that are compelling here. First price: prices on the major indices and on the majority of stocks cut through some important technical levels yesterday and not only did the near term trend turn down, but so did the sub-intermediate. Major technical damage was incurred on high volume yesterday.

Adding insult to injury, most averages and stocks are not yet technically oversold.

Also worrisome is the fact that we are seeing a number of commentators looking for a contrarian bottom to develop. Let's consider this. As noted, the VIX is at levels of fear not seen since the market made a major bottom and then rallied last March. But let's look back a little further to last year. In 2006 the market cracked in early May and by the end of the month VIX levels were spiking up to the level it is trading at today ($18-$19). The market did indeed bounce, but the bounce was merely of the dead cat variety. Before all was said and done, the market went on to fall for another two months and VIX levels moved all the way up past $23 before a major market low was put in.

The bottom line: With the mixed readings after yesterday's sell off it is important to be careful. The market should find some sort of support after such a strong sell off. A huge amount of technical damage incurred though and it is possible that the market could bounce weakly only to lull investors back toward complacency. Heavy caution is warranted here.