Why small caps might be signaling bigger problems: Pro

Traders work on the floor of the New York Stock Exchange.
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Traders work on the floor of the New York Stock Exchange.

Selling that started in small caps has spread to the major indexes, and now the S&P 500 and Dow are both signaling a possible broader selloff.

Paul LaRosa, chief market technician at Maxim Group, points out that the Dow and the S&P 500 both had "outside days" Thursday. That is when the trading range is above and below the prior day's range and closes below the prior day's low. The same phenomena happened in the Russell 2000 and Nasdaq last week.

"That led to significant underperformance in the Russell in the last week. What happened today was there were outside days in the Dow and S&P and that gives us some further evidence that some rough roads are ahead," said LaRosa.

The Dow fell 152 points Thursday, or nearly 1 percent to 15,593, a close below Wednesday's intraday low of 15,628. The S&P 500 was down 23 points, or 1.3 percent to 1,747, below Wednesday's low of 1,764.

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The Russell was off 1.8 percent Thursday to 1,079, and has now declined 1.9 percent in the last week. The Nasdaq was off 1.9 percent Thursday, at 3,857, and its one week decline is 1.6 percent. In the same week period, the Dow has been up 0.3 percent and the S&P off 0.5 percent.

LaRosa said the last time the Dow had an outside day was May 22, and that preceded a 6 percent selloff.

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"I don't think it will be as bad as it was in the last May to June period," he said. "I think it's going to be more like a 4 percent selloff."

The Russell and Nasdaq have led the declines this week, but both are still up more than 27 percent on the year, compared with the S&P's gain of more than 23 percent.

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"The small caps have been hit first. That makes sense because they were up the most, and now we're seeing it in the large-cap indices," LaRosa said. "It's all about probability, in my mind, and outside days are pretty predictive of the next market move."

He expects to see the Dow return to 15,200 before moving higher again, and the S&P could test the 1,700 area.

—By CNBC's Patti Domm. Follow here on Twitter @pattidomm.