What the market did last week is what the market does best – make a move when you least expect it.  While the market was certainly in overbought conditions and due for a retreat to major support levels, not many could have predicted the swift and decisive move downward right out of the gates to start 2005, crushing the majority of leading growth stocks in its path.  However, despite the damage, the market has managed to remain above major support levels, keeping the currently rally intact.. just barely.  At this point, given the number of distribution days just in the last week (Monday and Tuesday) and the technical damage done to many leading stocks (46 out of the top 100 ranked stocks in the Breakout Tracker have fallen below major support of the 50 day moving average, which is a telling statistic), there is certainly a bias towards further price erosion.  In order to avert a much larger correction, the markets will need to bounce back in a hurry next week with heavy buy volume.  Another high volume drop below major support levels and you can kiss the current rally goodbye (however, the longer term bull market trend would still be in place – see chart below).  Sure, and end to the rally so soon would not be what many expected, including myself.  But the market doesn’t care what you or I think.  You have to trust what the market is telling you in the language of price and volume.  Next week it should reveal more telling clues.

Let’s take another look at the chart of the Nasdaq:

The chart above shows the intermediate upward trend line, which is more or less the so called "mendoza" line (had to throw the baseball reference in there) for the current rally.  On Friday, this key support level was tested and is holding for now.  But notice also the difficulty the Nasdaq has had in getting back above support of the 50 day moving average (which now acts as resistance) around 2100.  That is an area that the Nasdaq will need to surge above with heavy volume if it hopes to avert a larger sell off.  The most telling sign of this correction is the amount of sell volume over the course of the week.  You have to go all the way back to the correction in 2000 to find a week with more selling volume!

The chart above illustrates the magnitude of last weeks decline, but it also shows that a drop below the intermediate upward trend line (shown in the first chart) wouldn’t necessarily mean the end to the bull market that began in October of 2002.  Most likely it would mean more of the sideways action we saw through most of 2004.  The "mendoza" line for the current bull market can be seen in the longer term trend line above, making the area around 2000 a very important support level should we get to that point.