Stock plunge puts S&P 500 at a critical point that could mean an even steeper decline

Published Thu, May 5 202212:19 PM EDTUpdated Thu, May 5 20226:31 PM EDT

Patti Domm @in/patti-domm-9224884/@pattidomm

Wednesday's Federal Reserve fueled rally gave some hope to stock market bulls, but analysts who watch the charts say Thursday's sharp sell-off is adding to a negative formation that could mean a big move lower for stocks. A so-called head and shoulders pattern has been building for some time, and chart analysts were watching to see whether the market would make its final dip and break the neckline when stocks sank on Monday. The big rally Wednesday was a reprieve, but now a new wave of selling has put the chart formation back in play, and it is sending a potentially negative signal for an even steeper decline. Chart analysts say the first shoulder was created last summer when the S & P 500 was at around 4,550. The head was formed in January at about 4,800, and the right shoulder was built in late March at about 4,500. "If it closes below 4,100, it opens the door for the next leg down," said Scott Redler, partner with T3Live.com. "That would mean the pattern is in motion." Redler said that could result in another decline to about 3,850 for the S & P. That would be a decline of about 7% from around the 4,150 area where the S & P was trading Thursday. "Earlier in the week, we tried it and could not stay below it pre-Fed. Now the Fed is behind us, and the bears proved they had some power today," Redler said. The most important level analysts are watching is Monday's low of 4,062. "That's definitely in the cross hairs. Anytime there's a low point or high point, people know about it and whether it's used as a real stop loss or point of reference, it's important to recognize," said Frank Cappelleri, executive director at Instinet. He said if the level is broken and the pattern completes, his downside target is even lower - at 3,460. "It's not broken yet but it's close. Every time we see a rally fail, it increases the probability that you could actually see that bigger pattern completed," said Cappelleri. Redler said the action Wednesday was a head fake for investors. "From false moves to fast moves, that's what's happening now. This type of action definitely puts the neckline in play for a break in the week or so ahead," he said. Redler said a big down move to the 3,850 might actually be positive for the market. "The market needs a real washout," he said. "The longer you wait, it sucks in more money and puts off the inevitable." There have been instances where a head and shoulders formation was nearly completed but then did not fully form. In 2010, the market rallied out of such a chart. "Back then everyone thought the market was going to correct...Then you had the Fed on your side, and you had a lot of things going on," he said. "Now the Fed is against the equity side." The Federal Reserve raised its target rate by a half point Wednesday, its second hike since 2018. Fed Chairman Jerome Powell sparked a market rally when he said the central bank is not now considering a 75 basis point move, as some bond market pros have been expecting. He did say the Fed would consider half point hikes at its next couple of meetings.

Traders on the floor of the NYSE, April 14, 2022.

Source: NYSE