The market suffered a strong setback on Friday when the recent strength gave way to a strong breakdown set in motion by a disappointing quarterly report from General Electric Co. (GE). GE reported that profits fell 6%. It said that its financial-services divisions bore the greatest responsibility for the shortfall, citing the U.S.'s slowing economy and the challenging capital market. GE's wide reach into other sectors, such as entertainment, manufacturing, and health care have increased market concerns. In addition to the earnings shortfall, GE has lowered its forecast for the year as a whole. The news came as a surprise, fueling concerns over what's to come this earnings season. GE lost 12.8% on the day. This was its greatest one-day decline since the 1987 stock market crash.

The market opened significantly lower on the heels of GE's blow. Typically the extreme gaps in the market, such as the one which took place on Friday, will fill within the first several hours of the day. To do so, they must begin that ascent within the first 15 minutes of the regular trading session. Otherwise, they are most likely to hold the gap and experience continued weakness throughout the session.

The market had begun to show some signs of a recovery attempt even before the opening bell, primarily in the S&P 500. The index futures had started to round off at lows, creating a momentum reversal pattern. The pattern held into the opening range, but the market was not able to move higher within the first 15 minutes of the day, creating a larger concern that the opening weakness would cloud the market's performance throughout the day.

The S&P 500 held the momentum reversal pattern, offering a decent setup heading into the 10:15 ET correction period. Although the S&Ps hit the first target on this pattern at 10:45 ET, based upon a plethora of resistance such as Wednesday and Thursday's lows and premarket levels, it was not able to push through that level. The resistance held and the indices began to reverse course, giving way to the larger odds that since the gap did not begin to close within 15 minutes that the bears would control the session.

The market shifted slightly into 11:00 am ET. It held congestion, however, until noon. Volume was light as the market attempted to hold up, but this simply meant that even though prices were moving slightly higher, there were not many willing to commit to it. At 12:15 ET the shift in momentum was very apparant. The Nasdaq was forming a short pattern and the S&Ps and Dow were also holding the lower end of the morning channel. This channel broke quickly, confiming the bearish bias for the afternoon.

The 12:30 ET correction period held as the Nasdaq hit support from Wednesday's lows. The market was unable to find any relief other than a stall in the selloff. Volume was light as the market rested within a congestion zone along the day's lows. When the 5-minute 20-period simple moving average hit at about 13:30 ET it triggered the next phase of selling. From that point onward the indices did not have as clear cut continuation patterns, but the market held the 5-minute 20 sma as resistance and continued lower in a steady trend into the close.

The breakdown on Friday signaled an end to the uptrend that had been in play since Bear Stearns (BSC) crashed on the announcement of its buyout by J.P. Morgan Chase (JPM) on March 17. Investors had hoped that the worst was behind them, but the momentum on Friday has triggered what could very well be a two-wave continuation pattern on the downside on the weekly time frame in the indices. The Nasdaq is going to have the best time trying to defy those odds, but the door has been opened for the S&Ps and Dow to make new lows over the summer.

In order to break this latest pattern, the market would have to chop lower for several months, overlapping price levels a great deal along the way. I do not think this is highly probable. On the plus side, since we are now in earnings season, a lot of individual stocks should offer strong momentum moves in response to earnings to play with. Earnings season will accelerate on Thursday. I will be much more cautious on anything longer term on the bullish side though for the time being until we begin to see how this pullback continues to play out.

The Dow Jones Industrial Average ($DJI) lost 256.56 points on Friday, or 2%. It closed at 12,325. The only one of the Dow 30 to stay in positive territory on Friday was WalMart (WMT), and that was only with a 0.24% gain. The S&P 500 ($SPX) lost 27.72 points, which also amounted a 2% decline on the day. It closed at 1,332. Safeco Corp. (SAF) (+2.39%), Clear Channel Communications (CCU) (+1.90), and Bed Bath & Beyond (BBY) were the top leaders. GE, Circuit City (CC) (-8.02%), and Countrywide (CFC) (-7.72%) were top losers. The Nasdaq Composite, which had the strongest upside in the prior session, had the most to loose. It fell 61.46 points, or 2.6%, and closed at 2,290. Among the top leaders were Fastenal Co. (FAST) (+4.06%), UAL Corp. (UAUA) (+2.23%), and BBBY. Some of the largest decliners were Nvidia Corp. (NVDA) (-6.70%), LAM Research (LRCX) (-5.86%), and Intuitive Surgical Inc. (ISRG) (-5.74%).

Dow Jones Industrial Average ($DJI)


S&P 500 ($SPX)


Nasdaq Composite ($COMPX)


Toni Hansen is President and Co-founder of the Bastiat Group, Inc., and runs the popular Trading From Main Street. She can be reached at Toni@tradingfrommainstreet.com.