Monday’s sharp selloff proved that the bears do have some life.

But is it enough to actually cause a noticeable stock market correction? The bulls have gotten a little too full of themselves, pushing the market into an overbought condition that is somewhat unusual. Now we will have to see if the bulls have enough firepower to halt the selling onslaught of Monday and to rescue the market once again.

The broad stock market had become overbought in an unusual way — by going sideways over the last couple of weeks. Usually, when the market goes sideways, that allows for overbought conditions to be alleviated. In fact, this particular bull market leg — stretching back to November 2012 — has done just that several times.

But this time, there was some internal buildup of overbought conditions. These included, but weren't limited to: Unusually heavy option volume in speculative stocks, increased momentum in stocks that were already stretched by having risen too far, put-call ratios at extremely low levels, and various volatility measures at extremely low levels, too. We’ll enumerate some of these as we describe the current market conditions.

Even with the sell-off Monday, it’s noteworthy that no serious technical damage has yet taken place. The broad stock market, as measured by the Standard & Poor’s 500 Index SPX, -1.11% held above support. For SPX, that support is at 1,810. It was a triple resistance area back in November and December (2013), and once it was broken on the upside (as a result of the positive Fed “tapering” announcement in December), it became support — and remains support until broken. There should now be resistance in the 1,830-1,840 area, now that the market has broken down from there, but the more important level is the 1,810 support.

Equity-only put-call ratios are technically on sell signals now. I say “technically” because they have been bouncing around at low levels on their charts for weeks now. At low levels, they are considered to be overbought. This overbought state was exacerbated, even while the broad market moved sideways for the past couple of weeks.

In fact, many of the broad market put-call ratios are trading at such low levels that they haven’t been seen since January of 2011. At that time, the market continued to rally for about another month before a sharp, but short-lived correction took place in February-March, 2011. Then, of course, there was a far more serious correction later in 2011. So the current low levels of put-call ratios is a warning sign — but unless these put-call ratios can actually start trending higher, rather than just wiggling around at the bottom of their charts, they won’t be seriously bearish.

Market breadth was poor yesterday, and that pushed the breadth indicators that we watch onto sell signals (just barely). Breadth conditions had been very overbought a few weeks ago. When the market moved sideways during early January, the breadth overbought conditions did abate somewhat, but they were never completely eliminated. Now they are on sell signals. These are very short-term indicators, in general, and they need to be joined by some other indicators before an intermediate-term sell signal can be generated.

Volatility indexes VIX, -2.38% XX:VXO have been at very low levels for about a month. This is another sign of an overbought condition. VIX traded below 12 on Monday before reversing upward, and VXO has traded near 11. Even so, the stock market can rally while these overbought conditions exist. For VIX to truly turn bearish, it would need to at least exceed the modest peak of December. That means VIX would have to close above 14.50 in order to say that it is in an uptrend. An uptrend in volatility is bearish for stocks.

The construct of the VIX futures remains bullish, however, and that is an indication that any market correction is just that — a correction, and not the beginning of a bear market. For this construct to turn bearish, the term structure of the futures would have to slope downward, and that hasn’t happened since the fall of 2011.

In summary, the bulls may have been startled by the severity of yesterday’s selloff. But that is typical for extremely overbought markets: No one wants to be the first to sell, but once the selling begins, everyone tries to squeeze through the exit at once — and there’s just not enough room. The technical damage is minimal at this point, and the bulls clearly have the opportunity to rescue the market once again.

We have a very clear demarcation line as to whether they are successful or not: the 1,810 level on SPX. If that is broken on the downside and VIX rises above 14.50, then the bears will be in charge; otherwise, it’s back to (bullish) business as usual.

Lawrence G. McMillan is president of McMillan Analysis Corp. He is an experienced trader and money manager and is the author of the best-selling book,“Options as a Strategic Investment” and editor of the “MarketWatch Options Trader” newsletter.

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