Deteriorating Technicals Suggest More Downside

(Editor's Note: RealMoney is free to all TheStreet.com readers until Monday night. We hope you enjoy this article. If you would like to subscribe to RealMoney, please click here. )

Going into Wednesday, I wrote that we were at a critical level, since the ascending trendline that defined the advance since March was being approached and threatened. Simultaneously, the Arms Index moving averages were still overbought on a short-term basis, making it appear even more likely that the structure would turn over to the downside.

The next day, after a small attempt to hold, the level was broken. In addition, as you can see on the first chart below, the drop became so big that the prior low was decisively broken. With volume increasing and the trading range growing, it certainly looked like a meaningful break.

The Arms Index got a big move on Wednesday, so the five-day moving average became a bit oversold. It was perhaps that oversold condition that led to the feeble attempt to hold Thursday. I would expect some better strength in the next few days, as the oversold condition gets worked off, but the damage to the market in the last few days suggests that there is more downside ahead of us after a small rally.

I am unwilling to try to play a rally at this time, in view of the deteriorating technical picture. I would rather use such a rally as an opportunity to put on some short positions.

---

To view a larger version of these charts (in some browsers), after clicking on the "larger image" link below the chart, mouse over the lower-right area of the chart until the icon with four arrows appears. Then click on that icon.

---

Click here for larger image.

Source: MetaStock

Click here for larger image.

Source: MetaStock

---

Harmonic: Buy

Click here for larger image.

Source: MetaStock

The move in Harmonic (HLIT - commentary - Cramer's Take) over the last few days may have gone a bit too far too soon, so I would be inclined to wait a bit, and see if it will pull back on lighter volume, before going in and buying.

But there are many encouraging indications on this chart. The March-through-May base provides a platform for a substantial advance. The last two rises have been on heavy volume with widening trading ranges. It has broken the descending trend, and moved above a key resistance level. It looks as though it is likely to go higher after a rest.

(To do my Equivolume charting, as in the charts that appear in this column, I use a charting program called MetaStock. To learn more about this method, read my series of columns, Trading With Equivolume.)

---

International Rectifier: Buy

Click here for larger image.

Source: MetaStock

I like the look of International Rectifier's (IRF - commentary - Cramer's Take) chart. Since March, it has been in a base-building phase, and now has a wide enough base to justify a substantial advance.

During the decline, volume was coming in on the declines, but now it is coming in on advances. The moving average convergence/divergence (MACD), across the top of the chart, has gone positive, and so have the two moving-average lines that overlie the price plot. I have inserted a horizontal line that indicates the old resistance level that will need to be overcome. I would be inclined to put on a partial position here, and round it out when and if the breakout occurs.

---

Johnson & Johnson: Short

Click here for larger image.

Source: MetaStock

The two-month advance in Johnson & Johnson (JNJ - commentary - Cramer's Take) seemed to come to a halt at the end of April. At that point, it had expended just about as much volume in the advance as had been developed in the base. Moreover, it was approaching the old highs where resistance was to be expected.

Now it has broken the ascending trendline and important support. The MACD has gone negative, and so have the two moving-average lines. We are starting to see volume come in on the downside. I would like to short a light-volume rally.

---

Marvel Enterprises: Short

Click here for larger image.

Source: MetaStock

Marvel Enterprises (MVL - commentary - Cramer's Take) is another possible short position. Because of the heavy volume, the Equivolume plots have been pushed to the right enough to break the ascending trendline, even though on a bar chart, it would look as though the advance was still intact. In addition, the MACD, across the top of the chart, has gone negative, and the moving averages are in the process of doing the same. I think it could be sold short around current levels.

---

At time of publication, Arms had no positions in the stocks mentioned.

Richard Arms is a renowned stock market technician who invented the Arms Index (often referred to as the TRIN), which has become a mainstay of market analysis, appearing in The Wall Street Journal and Barron's. Arms also developed the widely used technical method Equivolume Charting. Since 1996, he has been publishing the Arms Advisory newsletter for money managers and financial institutions. He also has authored Stop and Make Money: How to Profit in the Stock Market Using Volume and Stop Orders, Profits in Volume, Volume Cycles in the Stock Market, Trading Without Fear and The Arms Index, and has been honored with the Market Technicians' Award for Lifetime Contribution to Technical Analysis. Under no circumstances does the information in this commentary represent a recommendation to buy or sell stocks. Richard appreciates your feedback; click here to send him an email.

TheStreet.com has a revenue-sharing relationship with Trader's Library under which it receives a portion of the revenue from purchases by customers directed there from TheStreet.com.