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In last month’s article, we discussed how the market had been trading within a consolidation pattern for about six months and noted that a break below key support would increase the risk of a correction. That scenario has now played out.
Over the past month, market conditions have weakened, and risk has increased. While there has been a recent upside reversal, which is positive and worth monitoring, the weight of the evidence continues to suggest that the market is in a fragile state.
Breakdown Confirms Topping Pattern
The Nasdaq 100 ETF (QQQ) clearly illustrates the change in market character over the past month. In last month’s article, I outlined that the market was trading within a consolidation pattern and noted that a break below that range would signal a topping pattern and likely lead to lower prices. That is exactly what has occurred. QQQ broke below the lower end of that consolidation, confirming the topping pattern and shifting the trend to the downside.
Since that breakdown, the price has continued to decline and is now trading below both the 50 and 200-day moving averages. The 50-day moving average has also turned lower, which is an important signal that momentum has shifted. When price is below both of these key moving averages, and the shorter-term average is trending down, it typically reflects a weak market environment.
I have also drawn a downtrend line that begins at late January high. Price has respected this line as it has moved lower, further confirming the current downtrend.
In the lower panel, On Balance Volume provides additional confirmation. In last month’s article, I noted that a break below the OBV uptrend line would indicate distribution. That break occurred in early February. Since then, OBV has continued to move lower, and I have labeled this move as distribution. This suggests that institutional selling has been a consistent factor during this decline.
There has been one recent positive development. After a sharp decline on Monday, the market staged a strong upside reversal on Tuesday, with QQQ gapping higher and advancing on strong volume. While this type of reversal can sometimes signal a change in trend, I currently view it as a counter-trend move driven by short covering.
For this to evolve into something more meaningful, I would need to see additional confirmation, including a follow-through day on strong volume, a move back above the 21-day exponential moving average, and a break above the current downtrend line. Until that occurs, the weight of the evidence suggests that the market remains in a downtrend.
Client Account Update
Client accounts have been positioned defensively prior to the market breaking below the lower boundary of the consolidation pattern highlighted in last month’s newsletter. As conditions deteriorated, I chose to manage risk by adding short hedges rather than immediately selling all equity positions.
Many of the stocks we own have continued to display relative strength and are still trending higher despite the broader market decline. Because of that, I have maintained exposure to those positions while using hedges to help offset the impact of market weakness. This approach allows us to participate in areas of strength while managing overall portfolio risk.
Currently, both conservative and aggressive models remain significantly hedged. This positioning provides flexibility. As long as certain stocks continue to advance, I can maintain those positions while adjusting hedges as market conditions evolve. If conditions improve, I can reduce or remove hedges and increase exposure. If the market weakens further and even strong stocks begin to break down, I will take a more defensive approach by reducing equity exposure.
I am also continuing to see pockets of strength in select stocks that are advancing despite the market decline. Maintaining hedges allows me to selectively participate in those opportunities while keeping risk controlled in a challenging environment.