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In The Week Ahead: Time For Traders To Go On The Defensive

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The choppiness that has characterized the U.S. stock market since November continued last week, but this time with what appears to be some near-term directional implications.

All major indices closed well in the red for the week, led by the small-cap Russell 2000, which lost 5.1%, bringing its year-to-date loss to 6.7%. Just two weeks ago , I pointed out that the index was on the verge of a bullish breakout that could set it up for a retest of the June highs.

Since then, however, the Russell 2000 has failed miserably, and the weakness in small-cap stocks is now spreading to the other market-leading sector, technology.

This suggests that if Santa Claus is coming to Wall Street at all this year, he is taking a detour first.

Last week's sector performance was equally ugly, with all sectors of the S&P 500 finishing down, led by energy losing 6.6%. I'll discuss the weakness in energy and its implications for equity prices later in this report.

Apple Turns Rotten

In last week's Market Outlook , I pointed out a tentative bullish breakout in technology bellwether Apple (Nasdaq: AAPL ) following a month of sideways investor indecision. I said as long as underlying support at $118.25 held, it pointed to an eventual rise to $129.

Instead AAPL did a quick about-face early last week, not only collapsing back below $118.25, but also declining below the lower boundary of the indecision area before the week was out.

AAPL Chart

This indicates that, for whatever reason, investors have quickly and collectively changed their mind on price direction. It also suggests a near-term top is in place at the early November high, when AAPL initially failed to rise above its 200-day moving average.

The downward movement clears the way for a retest of the Oct. 1 low at $107.31, which is 5.2% below Friday's close. Moreover, considering the positive correlation between the stock and both the Nasdaq 100 and S&P 500, a decline in AAPL is likely to coincide with -- if not lead -- a market pullback between now and year end.

Follow The Leader

The next chart confirms such broader market weakness is already under way, as the bellwether S&P 500 collapsed below the lower boundary of its own month-long area of sideways investor indecision on Friday.

SPX Chart

The breakdown indicates a peak is in place at the Nov. 3 high and targets a decline to 1,965, 2.4% below Friday's close. That target will remain valid as long as the lower boundary of the indecision area at 2,057 contains the index as overhead resistance. Finally, the newly emerged bearish pattern negates the 2,135 upside target of the previous bullish pattern .

Defense, Defense!

A few weeks back , I said that despite some encouraging signs, the bulls should not let their guards down until some key overhead resistance levels were broken. I also recommended readers use the Volatility S&P 500 index -- better known as the VIX or fear gauge -- to protect their downside while waiting for a potential Santa Claus rally to kick in.

Those key resistance levels were never broken and, according to the VIX, it's time to play defense.

VIX Chart

The VIX rose above its 50-day moving average at the end of last week, which I use as a baseline to determine whether investors are collectively complacent enough to fuel a stock market rally or fearful enough to trigger a decline.

The last sustained rise above the VIX's 50-day coincided with the August-to-October decline in the S&P 500. As long as the VIX remains above that moving average, currently situated at 16.62, readers are advised to implement defensive strategies to protect their assets against a deeper market decline.

Beating Continues In Commodities

In the Nov. 30 Market Outlook , I noted lumber was the only commodity to show any price strength over the past few months and pointed to the iShares Global Timber & Forestry (Nasdaq: WOOD ) as a means to participate.

Following a 19% rise between late September and early December, WOOD had edged above its 200-day moving average. I said a sustained rise above it would be necessary to indicate a new investment opportunity.

WOOD then quickly retracted back below its 200-day moving average, though, indicating its larger February decline is resuming. Moreover, the ETF has declined below its 50-day moving average, a widely watched minor trend proxy. This suggests more weakness between now and year end.

WOOD Chart

Crude have been front and center in the financial media. West Texas Intermediate ( ) collapsed below $38 a barrel last week for the first time since 2009 and has continued to fall since.

Crude oil prices have been front and center in the financial media. West Texas Intermediate ( WTI ) collapsed below $38 a barrel last week for the first time since 2009 and has continued to fall since.

Oil Chart

Last week's decline clears the way for a move down to $30.81 per barrel, the December 2008 benchmark low, which is 13.5% below Friday's close. The weakness in oil prices exacerbated fears of global deflation and helped trigger and fuel last week's bearish reversal in stocks.

Putting It All Together

In last week's report, I said, "The sideways, non-trending activity in several major indices since November is likely to become the springboard for the market's next one-to-two-month directional move."

Given Apple's bearish reversal, the significant rise in the VIX and the potential for an additional 13.5% decline in oil prices, that move appears to be downward.

Although my intermediate-term (one to two quarters) outlook for the U.S. stock market is bullish, readers should consider adopting defensive strategies to protect assets in the short term. And stay tuned to Market Outlook , because I believe this decline will eventually provide us with a better buying opportunity.

News Chart

This article was originally published on ProfitableTrading.com:

Attention Traders: Time to Go on the Defensive

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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