After taking one big step forward, the market took two steps back on Wednesday as the Dow fell 733 points, or 7.9%, to close at 8,577. Of course, we are not surprised because we have been preparing for it. Yesterday’s downfall was blamed on bad retail sales data as September sales tumbled 1.2% month-over-month. Biggest drop in three years. The news was a shocker for Wall Street as it was a larger than expected drop. Know-it-alls predicted a decline of 0.7%.

As far as the indexes, the Nasdaq took a 8.5% hit and finished lower by 150 points at 1,628. The S&P was hit harder than a Vegas hangover, falling 9%, or 90 points, and closed at 907.

The Dow’s low last Friday was 7,773. For the Nasdaq it was 1,542 and for the S&P it was 839. So far we’ve been right-on in calling this market and we have prepared for a bottom, played the bounce, and now we must get ready for the possibility of testing those lows again. Remember, I keep telling you October will continue to be like this. That is why we are taking half positions over the short-term/ long-term and cashing in on profits by keeping tight stops.

As far as the bounce, it was good for a quick trade in Microsoft (MSFT, $22.66, down $1.44), Google (GOOG, $339.17, down $23.54) and Johnson & Johnson (JNJ, $60.54, down $3.46), Morgan Stanley (MS, $18.13, down $3.81) and Goldman Sachs (GS, $113.15, down $8.75). Keep an eye on the calls I have mentioned. Some of them are still higher but they may get cheaper. So here is the game plan.

First, if you take any positions, only start with a half position. What that means is that if you normally buy 10 option contracts at a time, buy five. The market keeps showing signs of another breakdown and to me, that would be the best thing that could happen.

Of course everybody is going to question the bailout package but the market needed to do its own cleansing and needed to make its own low before Congress jumped in. The truth is that Bush didn’t want a crisis and they wanted to jump start the market because it was at multi-year lows. But the reality is the market has to make a bottom on its own.

I studied charts until I was light-headed last night and here is my best/ worst case synopsis. I’ve already been calling for this decline since August before we hit last Friday’s lows. In fact, in the October 7 blog with the Dow at 9,447, here was what I mentioned:

“I’m not making any predictions on how low the Dow can go because on any given day we could get some kind of “miracle news” that takes the Dow higher by 1,000 points but from my study of the chart for the Dow, it looks like we could test 8,300. That’s another 1,000 points lower. From there it gets real ugly.”

Well, we got that and then some, son. I only repeat myself a thousand times because, again, I want to make you aware of what type of market we are in. You have to have a quick trigger and know what is happening. Having said that, there is support at 7,200 for the Dow but that’s another 1,300 points lower.

Although the talking heads thought last Friday’s 7,700 level was “the” bottom, some research will shed a different light on the subject if you are willing to do a little homework. This market can float like a butterfly and sting like a bee, that’s for sure. But it’s up to you to stay on your feet so that you can beat the Street. Don’t fall in love with any positions (yet). We still have earnings and October options expire next Friday.

Drumroll please…it’s possible we test those lows for the Dow (7,200) by next Friday with the hope of the market rallying afterwards.

Rick Rouse