Thursday's session amounted to a 'key reversal day'

The stock market's dramatic pullback from its intraday highs Thursday constitutes a textbook illustration of a "key reversal day," which has bearish consequences for at least the stock market's short-term prospects.

According to the standard definition, of course, a key reversal day occurs when the market hits a new intraday high and then closes down. And that, the stock market did on Thursday.

At one point in Thursday's session, in fact, the Dow Jones Industrial Average was up nearly 120 points, reaching the 10,955 level -- a new high for the bull market that began in March 2009. Reclaiming the 11,000 level seemed like a sure thing.

And, then, the rally abruptly lost steam. By the close, the broad market had slipped into the loss column for the session -- though the Dow finished with a 5-point gain.

Dramatic as Thursday's reversal was, though, its bearishness -- in and of itself -- is probably of just short-term significance.

That, at least, is the argument made in the latest edition of Technical Analysis of Stock Trends, the classic textbook on technical chart formations. Written originally many decades ago by Robert Edwards and John Magee, this textbook was updated as part of the latest (ninth) edition by W. H. C. Bassetti, who is an adjunct professor of finance and economics at Golden Gate University.

What could very well make the difference for whether weakness in coming sessions turns into something more major is sentiment. If the mood quickly turns sour in the wake of that weakness, then the bull market might very well secure another lease on life.

But if, instead, investors and advisers still refuse to build up their cash positions in the face of any such weakness, then contrarian analysis at least will conclude that bigger losses are in store.

It's too early to tell how sentiment trends will unfold in coming sessions, of course. But it's worth noting that Thursday's key reversal day comes at a time when bullish sentiment is at high enough levels to be a source of concern.

In addition, Ned Davis, of Ned Davis Research, reported on Wednesday of this week that his firm's so-called "Crowd Sentiment Poll," which is a composite of a number of separate sentiment indicators, had just risen into the "Extreme Optimism" zone.

As recently as this past February, in contrast, Davis' "Crowd Sentiment Poll" had been in the "Extreme Pessimism" zone. So there's been a huge swing in sentiment in a very short period of time.

Unless there is an equally big movement to jump back off of the bullish bandwagon in coming days, Thursday's key reversal could very well turn into a decline that is of more than just short-term significance.
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