Securities Research Services

Sunday, June 22, 2008

Levels of Support

The market sold off hard last week but the short side is getting riskier here. Today we are going to look at a few potential scenarios that could unfold from here and also at a few levels of support that may be important in the weeks to come.

After last week's hard sell off, the market is oversold. Oversold conditions can certainly remain that way for much longer than seems reasonable during a sharp downtrend, but the potential for short squeezes along the way down are always a risk when short positions are not timed well.

After an initial bumpy start, we timed our SPY short well and plan to hold here for the March lows, which should act as a magnet for the market over coming weeks.

Nevertheless, entering new shorts in this area are risky. We mentioned last week a study which showed that 40-45% of all bear market moves are bounces; some of them quite strong. After last week's sell off, a bounce up to the $135.25 area would be an attractive entry point to put on new positions, but we wouldn't add here.

One scenario to look for this week would be further declines that take the SPY temporarily below its 200-week average at $129.90. This would set up an excellent short squeeze bounce, which fits nicely into the timeframe of end of the month window dressing, which will start to take effect later in the week.

Longer term we would expect, however, that prices will work their way to the $125.50 area where support has been established both in March and late last year. It remains to be seen whether or not that support area will hold, so we won't get ahead of ourselves here.


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