We Can't Predict a Market Top, But We Can Watch the Closes
A series of weak closes can tell us a lot about the market, so here's why I'm watching the price action closely.
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The most common mistake that traders make is trying to predict a market top. In a market like the one we have now, there are always very compelling and logical reasons why the trend should not continue, but the market isn’t a reasonable beast. The market is highly emotional, and logical arguments, no matter how self-evident, can be ignored for a very long time.
The S&P 500 is set this morning to hit a new high for the 11th straight day. It has hit new closing highs for seven-straight days. The Nasdaq 100 has followed, while the Dow Jones industrial average and Russell 2000 have lagged badly.
What is most significant about the current market is the incredible narrowness of the strength. According to Jason Goepfert of SentimenTrader, the Nasdaq has had more stocks declining than increasing while the index hit new highs on nine of the last 20 sessions. The action under the surface is dramatically different than what the indexes are doing.
It is a highly unusual action and suggests that something substantial will eventually occur, but the challenge for investors is navigating the market effectively. Simply embracing a bearish posture can lead to tremendous losses as the trend continues. Trying to anticipate a turn in action that seems irrational is a recipe for frustration.
The best way to navigate this action is to wait for a shift in the price action. The biggest tip off that something is shifting will be a series of weak closes. Market turns tend to develop only after there is an intraday reversal. Stocks start strong and then have a surge of euphoric momentum that finally invites aggressive profit-taking and produces a weak finish. It may not trigger a sudden collapse, but a series of days when the bulls fizzle out, and there is a weak close is generally an indication that a shift in market character is occurring.
The other important issue in this market is the rotational action. If the laggards start to show more relative strength, there is a good likelihood that big programs will be at work to adjust exposure to various sectors. This is a dynamic that tends to last for a while and may indicate a shift.
Stop trying to predict when the market action will shift and focus instead on changes in the price action that indicate what investors are actually doing.
At the time of publication, DePorre had no position in any security mentioned.
