Stocks plunged Friday after traders, who were initially excited over Thursday's awesome third-quarter GDP numbers, awoke from their slumber and felt the urge to sell. And sell they did: The Dow Industrial Average (INDU) finished with a loss of 2.5% to close at 9,712 while the S&P 500 ($SPX) dropped 2.8% to finish at 1,036.

 

There was no shortage of catalysts for the decline. It was the end of the fiscal year for many portfolio managers, resulting in an increased in selling as profits are locked in and weak positions are culled. Bank stocks fell on word the government may require them to pay fees that will help unwind large firms that fail. Beleaguered small business lender CIT Group (CIT) inched closer to bankruptcy. It was reported that consumer spending fell in September. The U.S. dollar rose as overseas investors closed out carry trades funded with dollar borrowings. The list goes on.

 

But there reason for optimism. According to market sage Paul Desmond at Lowry Research, which one of the oldest technical newsletters on Wall Street, there is no indication that stocks are on the cusp of a major price top.

 

Desmond bases this observation on a combination of various long-term measures of market breadth as well as a proprietary measure of the supply, or selling pressure, of stocks. In his words:

 

"Every major market top in Lowry's 76 year history has been preceded by a sustained rise in Selling Pressure. With Selling Pressure recording a new 12-month low within the past two weeks, no such rise is now evident."

 

Translation: The evidence suggests stocks should level off here before resuming their march higher.

 

 

If you step back from the daily cut-and-thrust, it's clear that Thursday's big gains temporarily interrupted a minor correction that started on October 19 and had yet to fully run its course. (I wrote about the potential for trouble in a post back on October 21.)

 

Only very short-term technical indicators (including the percentage of stocks over their 10-day moving average) had moved well into oversold territory on Wednesday. Friday's action deepened the oversold condition, which as you can see in the chart above, has reached levels not seen since the March low.

 

This sets the stage for a potential rebound rally in the weeks ahead.

 

Note: The indicator used in the chart is the NYSE McClellan Oscillator, which is a momentum measure based on the number of net advancing issues minus the number of declining issues each day on the NYSE. Developed by Sherman and Marian McClellan, the Oscillator is calculated as the difference between 39-day and 19-day exponential moving average of the net advancing issues. You can find more information on the indicator and how to interpret it by clicking here.

 

Disclosure: The author does not own or control a position in any of the funds or companies mentioned.

 

Anthony Mirhaydari is a researcher for the Strategic Advantage investment newsletter. He can be contacted at anthony.mirhaydari@live.com. Feel free to comment below.