Major Downtrend Confirmed – Take Cover

Stocks opened lower on Monday following a sell-off in Europe. But a mid-afternoon rumor that the supercommittee had reached a breakthrough to cut $1.2 trillion from the U.S. budget turned stocks away from their lows.�

Despite the rumors of a budget breakthrough, however, the Dow Jones Industrial Average closed lower by 2.11%, the S&P 500 fell 1.86%, and the Nasdaq dropped 1.92%. Decliners outnumbered advancers by almost 6-to-1. The NYSE traded 931 million shares, and the Nasdaq crossed 534 million shares.

There was grim foreshadowing even before yesterday�s opening. The European and Asian markets closed sharply lower. But, worst of all,Germany�s DAX Index blew through a major neckline, confirming a breakdown from a head-and-shoulders formation. The target for the breakdown is 5,060, which means that the DAX probably will fall about 10% from its close on Friday.

As might be expected, the currency of choice was the U.S. dollar. The dollar as tracked by the PowerShares DB US Dollar Index Bullish Fund (NYSE:UUP) is rising in a bullish channel trend with support at its 50-day moving average (blue line). The MACD internal indicator is bullish, and even though it is somewhat overbought the pressure for foreigners to move to the safety of the dollar is so strong that the UUP could remain overbought for an indefinite period.

Most professionals watch the movement of the S&P 500 very closely since it represents a broad sample of some of the highest quality stocks. Yesterday, the S&P 500 broke through its 50-day moving average, confirming that last week�s threat was genuine. By failing to hold at the 50-day moving average and the support line at 1,220, the index confirms that a broad sell-off is under way, threatening the October low at 1,075.�

Selling could slow a bit at the midpoint of the August to October trading range at about 1,150. Such a decline would mirror the pattern illustrated on the German DAX and could spread to other exchanges around the globe.

The breakdown of the Nasdaq is even more impressive. This more speculative index started the day with vicious selling, which opened a huge gap. And despite a late-afternoon rally, it failed to close the gap. This type of gap is often referred to as a �breakaway gap� since it occurs at a major support line, confirming a major downtrend.

Conclusion: Friday�s tepid action produced little in the way of guidance to the market�s future direction. But yesterday�s sell-off broke through several major support zones and confirmed that a significant decline is under way.

Stocks are under attack and protective measures such as the purchase of puts or selling of calls should be undertaken by investors. But volatility is very high and big swings in both directions are likely. Traders should initiate strong, speculative trading strategies, especially on rebounds.

Even if a sharp rally from an oversold condition occurs, remember that vicious rallies are characteristic of bear market, and the bear market has resumed with full vigor.