NASDAQ Foreshadowing a Bearish Event?

By George Leong for Daily Gains Letter | Apr 23, 2014

The three-day buying streak last week offered some optimism that maybe the worst was over for the stock market, but my technical analysis of the charts indicates otherwise.

While blue chip and large-cap stocks are holding up fairly well, this cannot be said of the technology, growth, and small-cap segments of the stock market.

I previously discussed the stock market risk with high-beta stocks, but there are some warning signs on the charts that foreshadow a potential sell-off in the NASDAQ in the weeks ahead.

This stock market index had been down nearly 10%, which is the technical reversal point, but the NASDAQ managed to rally and is currently down only about seven percent.

The index is back above 4,000, but failure to hold would be the third time the NASDAQ failed to do so above this level, which would be a red flag for pending weakness in the stock market.

Take a look at the stock market chart of the NASDAQ Composite below.

As I indicate on the chart, there could be a bearish “head-and-shoulders” formation in development. Note the right shoulder (as indicated by the short blue horizontal line) followed by the head (as shown by the second short horizontal line).

The way this could play out is if the NASDAQ can hold near the current level of around 4,000, it could subsequently rally back to around 4,250.

At this point, if the index fails to extend higher towards 4,350 and falters, then we could see another downside move back towards 4,000 (as shown by the long blue horizontal line in the chart below). Failure to hold here could set the stage for a bigger downside move on the chart, which would complete the head-and-shoulders formation.

Chart courtesy of www.StockCharts.com

While the technical chart formation may or may not surface, it’s something that you should be aware of, especially if we fail to see any sustained leadership from technology and other growth areas, such as biotech.

The reality is that there are many stocks on the NASDAQ 100 that have already corrected more than 20% and are thereby deemed to be in a technical bear stock market.

Netflix, Inc. (NASDAQ/NFLX) is down 27% from its high. Tesla Motors, Inc. (NASDAQ/TSLA) is down 26%. Twitter, Inc. (NYSE/TWTR) is down 39%.

If these previous momentum and brand-name technology stocks fail to attract sustained buying, then we could see more downside moves for this group in the upcoming months.

Given this, I would be careful in jumping in at this point. Instead, I’d wait for some sustained buying support in the stock market and renewed leadership from the technology group.

If the NASDAQ looks to be setting up for a fall, you could short Powershares QQQ (NASDAQ/QQQ) or buy a short-based exchange-traded fund (ETF), such as ProShares UltraShort Technology (NYSEArca/REW), which is based on the Dow Jones U.S. TechnologySM Index.

Alternatively, if you hold mainly technology stocks in your portfolio (which isn’t great for diversification), you can simply buy put options on the QQQ.