Each weekend, I study market behavior using sentiment and technical indicators. The goal is to use clues, observation, and indicators to determine if we are in a bullish, bearish, or sideways market environment.
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AAII survey (11/5/2014)
52.7% Bullish. 15.1% Bearish.
Bearish: If sentiment is over 50% bullish.
Bullish: If sentiment is over 50% bearish.
Investors Intelligence (11/4/2014)
54.6% Bullish. 15.1% Bearish
Bearish: If sentiment is over 60% bullish.
Bullish: If sentiment is over 60% bearish.
VIX: 13.12 (on 11/7/2014)
Bearish: Less than or near 12.
Bullish: Greater than or near 40.
Moving Averages (daily): The S&P is above its 50-day, 100-day, and 200-day moving averages and pointing up.
Bearish (Short-term Downtrend): Index crosses below 50-, 100-, or 200-day MA.
Bullish (Short-term Uptrend): Index crosses over 50-day, 100-day, and 200-day MA.
MACD (S&P 500): MACD is above its zero line, and above its red 9-day signal line and pointing up. (Note: I’m using the settings, 19,39,9, recommended by Gerald Appel, MACD’s creator.)
Bearish: MACD line crosses below 9-day (red or gray) signal line. MACD line (black line) crosses below zero line.
Bullish: MACD line crosses above 9-day signal line. MACD line crosses above zero line.
RSI (S&P 500): RSI is at 67.04 (on 11/7/2014)
Overbought (i.e. Bearish): When RSI rises to 70 or above.
Oversold (i.e. Bullish): When RSI falls to 30 or below.
Note: RSI can remain overbought or oversold for extended time periods.
Bonds: U.S. 10-year yield is at 2.65% (on 11/7/2014)
Note: 3.0% or higher is significant (consider selling bond funds as yield rises). 3.5% or higher and risk increases (for bondholders).
Analysis: The indicators and clues are pointing in two directions. The indexes have firmly surpassed their moving averages. In addition, MACD is in an uptrend. If you are looking at the technicals, you can’t help but be bullish. The sentiment indicators, on the other hand, are flashing warning signs. While the market climbs higher, retail investors are feeling overly exuberant along with money managers and financial writers. The AAII sentiment survey is showing the lowest number of bears in many years. In addition, the VIX is back to its lows and the RSI is showing overbought conditions. What does it mean? It means we could still go higher but caution is strongly advised.
Opinion: Who are you going to believe: the technical indicators or sentiment indicators? As you see above, there is a major divergence. If you follow the trend, which is usually a prudent idea, you are long. Typically, the trend is your friend and when the market is above its moving averages (among other things), the odds are good that you will be on the right side of the market.
On the other hand, the market rebounded so fast and so quickly that the trend could be going parabolic, which is a red flag. It is not surprising that the majority of investors and money managers are wildly bullish right now. Everything seems to be going their way.
In my opinion, the market is going higher, but on fumes. It won’t take much to send this market lower. Once the crowd starts to feel nervous and fearful, they’ll sell in a heartbeat. Unfortunately, no one can predict when that will happen. Note that I said, “Will.” Yes, the markets will reverse direction one day, and there will be a major correction. It’s taken a long time, and you may have to wait longer.
Here’s what I’m doing: As a long-term, patient trader, I make the most money when the market is volatile. We had a volatile market a few weeks ago, but that temporarily ended. Now we’re back to the daily “V” shaped buy-on-the-dip rally. Very little volume and volatility, just the way long-term investors like it. If this keeps up, we’ll be at 18,000 by January.
If you are looking to make (or possibly, lose) big money, when the market gets volatile again, you can take action. There are several ways to do this: ETFs and options are my preferred methods, but skilled traders might trade individual stocks as well.
When the market gets volatile again, remember this rule: Take profits quickly! I still believe this uptrend is on its last legs, but knowing when it will roll over is difficult to predict. I take it one day at a time. Nevertheless, when this current rally falters again, be ready to take action (if you dare).
Bottom line: Because of the divergence of technical and sentiment indicators, it’s impossible to predict where the market will go this week. If possible, be on the sidelines in cash and get ready to plunge when the market reveals its hand. Be patient, as always, and be prepared for volatility. That’s when traders will shine and many investors will run for cover.
* Note: These signals are not actionable trades, but only guidelines. Always use other indicators, and your own research, to confirm before buying or selling.