Pullback enters ‘sell-on-rally’ phase

By Tomi Kilgore of Dow Jones

NEW YORK (MarketWatch) — The market’s bounce on Wednesday marks both the end of the beginning of downturn and the start of the next phase, which means investors have to get used to doing something they haven’t done in long time: selling on rallies.

The first phase of a pullback is when investors who have been waiting for some technical trigger to start taking money off the table finally get one. This entails a shift in stance from “buying on dips” during an uptrend to “selling on declines’ when that uptrend breaks.

The S&P 500 /quotes/zigman/3870025 SPX +0.74%  already passed through this phase. The index slid 4.3% over the previous five sessions as it sliced through an uptrend line starting at the October low and dropped below the 50-day simple moving average, or SMA, for the first time this year.

Now the index is ready to enter the next phase.

With the trading bias now negative, Brean Murray Carret technical analyst Frank Longman said Wednesday’s bounce will likely bring out something that hasn’t been seen in months, “sellers into strength.” With that in mind, he said the focus now becomes “defining the most logical resistance levels.”

The first big level, and therefore the most important for the short-term outlook, is the 50-day SMA.

There is a Wall Street saying that more can be learned from a market’s failures than its successes. If the S&P 500’s bounce ends before it can comfortably clear the closest resistance would indicated that the “sell-on-rally” camp isn’t only crowded, but itchy.

And consider this: after months of being accustomed to “buying on dips,” the fact that it only took a five-session slide to get Wall Street traders to do the opposite speaks volumes about the strength of the downside momentum.

The 50-day SMA came in at 1373.09 on Wednesday, according to FactSet Research, and was rising by about one point per session.

Meanwhile, the S&P 500 was up 1% at 1372 in midday trading, off an intraday high of 1374.70.

If the index eventually gets through the 50-day SMA, the next logical resistance is 1382, which is the 38.2% retracement--one minus the Fibonacci ratio of 0.618--of the drop from the April 2 intraday high of 1422 to Tuesday’s low of 1357. Other Fibonacci retracements are 50%, or 1390, and 61.8%, or 1398.

Failing to reach this first Fibonacci retracement threshold would suggest the beginning of the pullback isn’t quite over yet, and traders better get ready to sell on declines again.

Downside levels to watch start at Tuesday’s low around 1357, followed by the March 6 low of 1340.

This column originally appeared on Dow Jones Newswires.

Tomi Kilgore writes about the markets for Dow Jones Newswires.