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This column was originally published on RealMoney on Aug. 1 at 12:35 p.m. EDT.

Friday's sharp reversal marked the first time in the last eight trading days the

S&P 500


printed a lower low than during the prior session.

The persistent selloff unraveled Thursday's thin rally, ending a good week on a sour note.

So is this the start of a large-scale decline, or just a short detour on the road to higher prices?

Several weeks ago, I outlined arguments for

an intermediate-term top near 1250 on the S&P 500.

While the major averages held up longer than expected, they have moved right to the price pivots that could yield a correction back to the 2005 lows. But the jury is still out.

Topping Action

At a minimum, we should see topping action before any acceleration to the downside. The S&P's rising channel, defined by the higher lows, gives traders a focal point to divine the market's intentions.

Simply stated, a channel break suggests the four-month rally is finally coming to an end.

But broken trend lines don't shift markets from uptrends to downtrends immediately. Instead they mark the beginning of a sideways or topping phase.

So the S&P could still test the rally highs after breaking the channel. But the odds then shift toward a reversal that takes out the lows of the current downswing, wherever it ends.

As readers know, I've had my suspicions about this rally for some time. The volume pattern is really odd and we haven't seen the typical "two steps forward, one step back" action of a healthy market climbing a genuine wall of worry.

Helene Meisler outlined my latest misgivings last Thursday, noting the lack of confirmation in

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market breadth and volume action.

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While poor breadth can be overcome early in a rally, its appearance late in the game is usually the warning sign of a topping market.

The quality of upside momentum has also been suspect for several weeks now. Big moves have been confined to chat-room stocks and after earnings surprises, where one side is caught off guard and trapped.


(AMZN) - Get, Inc. Report

vertical rally last week offered a great example of this second scenario.

My late July performance reflects intimate experience with this erratic momentum. While earning reports haven't hurt me that much, I've bought a series of breakout patterns that tagged new highs and then fell apart, triggering my stop-losses. This isn't typical price action in a healthy market, either.


The financial stocks should also be acting better, rather than hitting new lows for the year. The terrible price action in


(C) - Get Citigroup Inc. Report

is being repeated all over the banking sector. Just look at the persistent declines in

Bank of America

(BAC) - Get Bank of America Corp Report


J.P. Morgan Chase

(JPM) - Get JPMorgan Chase & Co. Report


The S&P 500 looks unaffected by this decline because energy stocks have taken over leadership from the financials. While this keeps a floor under the index, it isn't healthy in the long run. The reason: Rising oil prices will eventually dampen blue-chip profits significantly.

Once again, let me draw on Helene's excellent work and say that

the banks appear ready for an oversold bounce. Readers can play this in two ways. First, buy financials that performed better than the broad sector on the last downturn. Second, sell short the most vulnerable components when they rally into resistance.

Golden West Financial

Here are trade setups for both sides of this equation. I'll be looking to buy

Golden West Financial


early this week as long as it holds above the 50-day moving average. The stock broke out to a new high earlier this month, but sold off after earnings. The original breakout pattern will stay intact as long as the stock holds current levels.

Fannie Mae

On the flip side,

Fannie Mae


broke key support at $57.30 last week and sold off toward $55 on Friday. An oversold bounce in the financial sector could bring this stock up to resistance in the next few days. That price level should mark a good short-sale entry for a decline to $50.

Above all else, traders shouldn't overplay their hands on either side of the market in the next few weeks. While the indices may be topping out, we're now into the low-volume dog days of August. This thin environment could be treacherous for long and short positions.

Until Labor Day, turning profits will require strong filters that lower the high seasonal noise levels. It should be a time when longer-term positions taken at price extremes perform better than quick daytrades or one-night swing trades. In any case, expect your stops to be targeted this month in sudden shakeouts and nasty whipsaws.

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Alan Farley is a professional trader and author of

The Master Swing Trader

. Farley also runs a Web site called, an online resource for trading education, technical analysis and short-term investment strategies. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback;

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