After chopping around during most of the holiday-shortened week, stocks nosedived last Thursday, tipping the balance of power in favor of the bears. The major indices gapped sharply lower on the open, then drifted sideways to lower throughout the rest of the session. By day's end, key technical support levels were broken, and the main stock market indexes had each fallen several percent. The Dow Jones Industrial Average tumbled 2.6%, the S&P 500 2.7%, and the Nasdaq Composite 2.9%. The small-cap Russell 2000 and S&P Midcap 400 indices plunged 3.9% and 3.3% respectively. All the broad-based indices closed at their dead lows of both the day and week.

Total volume in the NYSE receded 25%, while volume in the Nasdaq was 2% lighter than the previous day's level. Considering the sharp losses in the broad market, it's positive that volume levels remained tepid. However, remember that turnover is typically light ahead of three-day holiday weekend regardless. In our July 1 commentary, we warned that the S&P 500 registered its fifth consecutive "distribution day" (loss on higher volume) in the preceding session. Specifically, we said, "When the market sells off on higher volume, it indicates selling amongst mutual funds, hedge funds, and other institutions. An occasional bout of such distribution is normal, and can usually be absorbed by a healthy market. However, the presence of five or more days of institutional selling within a period of several weeks very frequently leads to a substantial correction in the broad market. While negative volume patterns alone may not be sufficient cause to blindly sell long positions, astute traders heed the legitimate warning signal of numerous "distribution days" by tightening stops and holding off on entering new positions until the underlying market internals improve." Traders who heeded that reliable warning of five "distribution days" were indeed rewarded the very next day, as stocks got hammered across the board.

In addition to discussing the stock market's bearish volume patterns in the July 1 issue of The Wagner Daily, we also brought to your attention the bothersome "head and shoulders" patterns that were forming on the daily charts of the S&P 500 and Dow Jones Industrial Average. At the time, both indices were forming "right shoulders," and we pointed out that a breakdown below their "necklines" would probably lead to a swift change of overall market sentiment. Despite last Thursday's selloff, both indexes are still holding above their "necklines," but only marginally.