Daily Commentary 8/10/2011

By Lawrence G. McMillan

The market, after some nasty downside fakeouts, finally staged the oversold rally that we – and many others – had been expecting.  In slightly less than an hour and a half, $SPX rallied roughly 80 points!  Earlier in the day, a rally had been underway also, but it was a nervous one as the market awaited the comments from the Fed after the FOMC meeting.  Those comments were taken quite negatively by the markets, and stocks went into something of a freefall right afterward, with $SPX losing all of the previous gains and dropped a total of 50 $SPX points in about a half hour of trading.  The late-day rally followed that.  So, Fed "lovers" will say the Fed caused the rally.  More practical analysis though, is that the oversold condition caused the rally, and it couldn't take place until the post-FOMC selling got out of the way.

In any case, the market is still quite oversold, and in a very tenuous state.  As we noted yesterday, these oversold rallies are not lasting affairs, and the lows are likely to be tested again in the next week or so – if not before.  There will even be some disagreement as to what the low is, since the overnight low was 1077, but the day session low was 1097 (both in terms of the S&P futures).  As for upside profit potential, the first rally doesn't usually make it all the way back to the 20-day moving average of $SPX.  But for reference, that average is at 1280 and falling at the rate of about 10 points per day.  Neither the oversold rally after the May 2010 "flash crash" nor the oversold rally in October 2010 nor the rally on the two days after the Crash of ‘87 (all times that were similar to today) reached the 20-day moving average on the first attempt, but they did manage to get back within 1.5 standard deviations of it.  That would target this rally at about 1230 or so.  However, reality is often a slap in the face, and it must be noted that S&P futures are down about 8 points right now and have not been able to rally much at all overnight in Globex trading...

To read the rest of Larry's Market Commentary, subscribe to The Daily Strategist Newsletter.