While I am firmly in the camp that believes we have set a very important generational low, I have to say the market is starting to get ripe for a swift correction as it approaches some key resistance levels. Recently, I've noticed the level of bullishness on the stocktwits stream increasing and many sentiment indicators are revealing a similar pattern. While the current market still has some room to continue in the near term, some indexes are approaching a key resistance level after what has been a great rally.
While some indexes like the Russel 2000 and Nasdaq 100 have already cleared similar resistance areas, the key index I am watching is the S&P 500. This is because most of the concerns during the recent bear market revolved around the financial stocks and thus it would take more confidence from investors to push this index back above key resistance levels. I recently mentioned this thought in one of my recent market review articles and I thought it would be a good time to post a long term chart to show what I'm looking at.
In looking at the chart below, I am using SPY as a proxy for the S&P500. I highlighted a couple of important highs from 2008. The first level is near SPY $142 and is where some would argue the bear market began as the markets set a lower high after breaking down from their base. While this is certainly an important level, the next lower high set in August near $131 is also worth watching. This is when the bear decline really picked up steam and not coincidentally, when most retail investors started to panic.
As humans, we have a tendency to not want to lose. As such, one common behavior in the markets is for a trader always look to get back to "Break Even" after a loss. This is one area where many traders would feel they are "back to even" and look to protect themselves. I've noticed that while many traders are becoming increasingly bullish, many still doubt the rally off the 2009 lows because it is largely manipulated and currency based. This is actually powerful fuel for further gains in the markets longer term, but shorter term there are some warning signs that we are close to another inflection point.
Recently, many trash stocks have risen to being among the best performing and most active stocks. This is usually a warning sign that market participants are chasing rewards rather than acting prudently. Many market leaders are also slowing down and seeing some profit taking. There are many possible scenarios unfolding, and in my opinion the ideal action right now would be for the markets to trade sideways in a tight pattern building up fuel for a real breakout. However, this is not a likely scenario judging by the recent action and the fact that we still have some room to run in the near term. Some key indicators like the Mclellan and Worden's T2107 have room before becoming really overbought, so its possible that we squeeze higher before reversing. In either case, I am preparing for all sorts of scenarios, and the market continuing higher through these levels without a correction of some sort is the least likely. Traders should continue to respect the current rally as it has continued to frustrate shorts, but I for one have been protecting profits and keeping my trades very short recently.
Good Trading,
Joey
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