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The past few sessions have produced a significant correction in major indices, but the long-term uptrend has not been violated. What that means for investors is that while this correction is uncomfortable, so far it is nothing out of the ordinary. I’ve included a three-year chart of the Nasdaq so you can see how the current downturn compares to recent corrections. 

The black line is the Nasdaq and the gold line is a simple 200-day moving average (MA). In this case I am using a 200-day MA because I think breaking it establishes the possibility of a change of direction in a long-term trend. For short-term trends I use a 50-day MA and at the end of yesterday’s trading, the Nasdaq was resting right on that mark. In today’s trading it broke significantly below that level.

Notice that the last time the Nasdaq broke below its 200-day MA was during the correction that began in May 2006. That correction ultimately went much lower, but it still took the Nasdaq only about 90 days to recoup those losses.  The two prior corrections in 2005 the Nasdaq quickly rebounded after breaking below the 200-day MA.

Stocks have sustained a fairly steep rise for the past year with a lone pullback early in 2007. Downside activity is inevitable. It is the nature of the markets. But so far the long-term advance has not been violated. I anticipate that the Nasdaq will not correct much below its 200-day MA. In fact, if you look at the red trendline that I added to the chart, I suspect that the correction will stop at that level. That would put the Nasdaq at about 2550. Today it closed at 2599.

Of course I have always said that no one has the ability to predict market movement, including myself. So if I am wrong and the Nasdaq breaks below its 200-day MA, I would then sell positions as a defensive measure and buy again when the index crosses back above its 200-day MA on the upside.

The bottom portion of this chart is a Moving Average Convergence Divergence (MACD). I wrote about this indicator a couple of weeks ago. At this point the MACD is still positive, but falling. If the Nasdaq breaks below its 200-day MA, I suspect the MACD will go negative.

The blue line on the chart shows the long-term trend that I believe is still intact. I think once this correction ends, the Nasdaq will rebound back to this trendline and we will see new highs again, probably in September.

What about other indices and sectors? The Dow is faring slightly better in this correction and so far the S&P 500 is doing slightly worse. International markets are likely to correct more sharply than the U.S. The old saying is that when the U.S. market catches a cold, the rest of the world markets get pneumonia. In general, any sector that has outperformed the Nasdaq on the way up will probably also lead on the way back down. That is the bugaboo of volatility and risk.

So as uncomfortable as this is right now, my best advice would be to hold tight unless you have positions that break decisively below that 200-day MA.
F.S.