Will The Pullback Continue?

By Joey Fundora | January 04, 2011 AAA

While Tuesday's down day in the markets was relatively tame as far as the major indexes were concerned, many former market leaders suffered a high volume selloff. Even though one distribution day isn't usually enough to change the overall trend in a stock, it does shock current market participants and will likely have a residual effect moving forward. Often when a stock suffers a violent down day, the low will act as a resistance level as worried market participants begin to sell on any bounces back into the selloff day's price range.

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BJ's Restaurants (Nasdaq:BJRI) is an example of a stock that was hit pretty hard Tuesday as it fell more than 5% on a huge increase in volume. BJRI had been a leader in its group for much of the year and remains in a longer term uptrend despite the sharp selloff. BJRI had been trading sideways after a strong move higher through November and early December. After testing its 50-day moving average, BJRI finally caved in and dropped sharply. While this down day may not mean BJRI is going to begin a new downtrend, it is likely to act as a resistance level for some time. This could lead to sideways action as BJRI attempts to digest the selling pressure.

Source: StockCharts.com



O'Reilly Automotive (NasdaqGS:ORLY ) is another stock that had been in a longer term uptrend. It was steadily rising before a pullback in late December. It started to rebound heading into the New Year but fell apart on Tuesday, slicing through its 50-day moving average on high volume. It closed near the $58 level and wiped out almost two months of gains. While the $57-$58 level may be a support area, it will likely take a lot of time for ORLY to absorb this selling pressure and become healthy again. The $60-$61 level may hold back any advances in the near future as traders who were caught in the selloff attempt to mitigate their losses.

Source: StockCharts.com



DSW (NYSE:DSW) also sliced through its 50-day moving average on high volume this week. It had been building an ascending triangle pattern after a strong rally in late 2010. This is typically a continuation pattern, and the sharp decline surely caught some participants off guard. The $35 level held on a pullback in November so it may do the same on this pullback. What traders need to realize is that DSW will likely need much more time before it can seriously muster a breakout attempt.

Source: StockCharts.com



Another stock that appeared to be in a continuation pattern is Yum! Brands (NYSE:YUM ). YUM had been consolidating an advance through much of November and December. It started to show weakness by slipping under its 50-day moving average in December, but had managed to stay above a November pivot low. However, Tuesday's decline pushed YUM under its entire base, and occurred on an increase in volume. Traders should watch the $49 level closely now; it was acting as a floor for the stock, but now that the stock has breached this level it could act as a ceiling. (For more insight, read Support & Resistance Basics.)

Source: StockCharts.com



Bottom Line
Traders should be cautious when individual leaders begin to start seeing profit-taking. Often a general market index will continue higher as its leaders begin to show signs of weakness. Sometimes the weakness can be attributed to an individual story in a stock, but sometimes it's the "canary in the coal mine", offering a warning that the market is getting tired. Even though the recent negative day isn't necessarily the start of a new downtrend, there is a good chance it is signaling a change in character. It will take some time for each of these stocks to absorb this selling pressure, so traders should not be in a hurry to jump right in. If the stocks remain healthy, they will enter a period of sideways consolidation before building enough energy to challenge the highs set last month. The key is to watch the behavior of other leaders to see if this price action begins to spread. (For more, see Technical Analysis: Introduction.)

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At the time of writing, Joey Fundora did not own shares in any of the companies mentioned in this article.

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