My mind has been contemplating a few possibilities for this upcoming week. Certainly it is probably one of the most anticipated weeks of trading ever in the USA stock market.
The world world knows about the downgrade of the USA credit rating by now, but what does this mean for the markets on Monday?
A case can be made that the markets will do a very large bounce higher because A. The markets are in extreme oversold territory and B. Because the debt downgrade news was already price into the market (and that's why we declined into the news).
I think the downgrade news was already priced into a lot of the market decline so far. But I do not think the market is just discounting the USA down grade news. It is discounting a scenario where USA stocks could be setting up for survival in a zero growth environment. It is also discounting possible huge dislocations in Europe and Italy which could cause contagion in various markets and instruments world wide.
I could go on and on trying to second guess the market about what it has already discounted or what it has not discounted so far.
From a technical analysis standpoint, I can say that the markets are currently in an extreme oversold state when we look at such indicators such as RSI. The problem is that occasionally and very rarely when the market is in such an extreme oversold state it can go to a hyper extreme state of oversold. This is exactly what occurred in 1987 crash.
It has been a long time since we have had a 1987 style crash in the markets. 1987 was the most unique type of crash in that prices went down very fast but then also STAYED down. Most other panic declines I have seen over the years have been fast and sharp declines, but they have been roller coaster type declines that are somewhat slow and orderly.
But the 87 style crash was fast and relentless and almost literally dropped like a rock and stayed down.
I have been thinking that if this Monday August 8, 2011 is going to be a down day, it may be a 20%er. I say this because RSI is already into the bearish powerzone under the 30 range. The time to bounce is NOW. If we do not bounce then it risks a market slide perhaps somewhat similar to the 1987 style.
Other clues that this may be the case come from the current speed of the decline and the nature of the price candlesticks which are closing with big red full bodied 20/20 bars and closing at the lows of the day. That was the nature of the candlestick pattern during the 1987 crash.
The market has presently shown us that is is not respecting bounces. It is not allowing longs to get out. This is a worrying sign for the week ahead.
I certainly do not want to see an 87 style drop this week, but if we see Monday looking like it will be a down day that possibility could come into a high probability.
In my previous post I did a 2011 2008 pattern comparison that makes the argument that we could see a huge several day bounce in the markets... that would be scenario B and could possibly make this decline more of characteristic of the 2008 style decline that is more waterfall type action instead of 'drop like a rock' type action (1987).