What Does the Dow’s Bearish Key Reversal Day Mean for You?

 Long-term investors should be bargain hunting while traders should execute bearish strategies

By Sam Collins, InvestorPlace Chief Technical Analyst 

New York, Feb.21, stock investing .- Stocks started Wednesday on a down note, following a drop in new residential construction in February. But after the release of the minutes from the Fed’s latest meeting, the equity markets tumbled.

The Fed minutes indicated that some members were uncomfortable with continuing the easy-money policies and “expressed concern about the potential for excessive risk-taking and adverse consequences for financial stability.” And the board agreed to “discuss the matter in more detail” at the March meeting. Some members said that they would consider reducing or might even “end its purchases [of bonds] before it judged that a substantial improvement in the outlook for the labor market had occurred.”

At Wednesday’s close, the Dow Jones Industrial Average was off 108 points at 13,928, the S&P 500 fell 19 points to 1,512, and the Nasdaq was off 49 points at 3,164. The NYSE traded 816 million shares and the Nasdaq crossed 477 million. On the Big Board, decliners outpaced advancers by 3.1-to-1, and on the Nasdaq, decliners were ahead by 3.6-to-1. 

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The reaction to the Fed minutes led to a bearish key reversal day (KRD) for the Dow. This signal is characterized by a daily bar that reaches a new high, and then turns around to close lower than the previous bar.

Most technicians accept that this pattern is notice of a pending market decline. But there are some who would say that it signals a “market top,” because there are many examples of a modest pullback after the signal followed by a resumption of the major trend.

Conclusion: The Dow was the only major index to flash a bearish KRD even though most came close. The S&P 500’s highs on Tuesday and Wednesday were identical at 1,530.94, just 0.01 points away from a KRD. The Nasdaq missed a new high and thus a KRD by just 0.35. 

Nevertheless, the stock market is still extremely bullish, and following a modest pullback, should make a run at another round of new highs. But the short-term trend is now down, and traders should be executing bearish trading strategies. Long-term investors should sharpen their buy under prices and grab bargains as the market retreats for what could be a 3%-5% pullback. 

Initial support for the Dow was its 20-day moving average at 13,940, but that was penetrated Wednesday. The next support is the line at 13,860, then the major breakout line at 13,653, and finally, the 50-day moving average at 13,569.