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By Chris Rowe - Creator: Technical Analysis Millionaire
There are currently 2 glaring signs of an overbought market. Whenever I've seen these signs, the market has dropped soon thereafter. It's like clockwork.1. Market participants are overly complacent -- heck, they're overly bullish. Just turn on the financial television. No wait, scratch that. Just trust me: there is a bullish love-fest happening. It's ridiculous.
But their comments are not precise enough of a sign. The statistics are showing a "crowded trade" again.
The Investors Intelligence Advisors Sentiment Index shows that 53.2% of the newsletter writers and advisors they poll are bullish. Red flags start to go up when this weekly reading gets over 50 (which happened on Tuesday, January 8), and a reading over 55% is considered "dangerous territory".
2. Market internals are overbought in every time frame (long-term, intermediate-term & short-term). I won't load the article up with charts, but my TAM students will understand when I say the "NYSE BPI, the %30-week and the %10-week" are all showing stock prices to be overbought.
So that's Sentiment and Internals that both say "overbought".
Sure, you've probably heard the old Wall Street adage "Overbought doesn't mean over". And markets can certainly push a bit higher from here. You may notice, in the chart above, how market participants were overly bullish for about 3 months in late 2011/early 2012. Do understand that the same was true in that time frame with market internals.
The sentiment and internals usually don't stay overbought for such a long time, and it's best to trade based on what USUALLY happens. But you should know that what I just mentioned does happen sometimes. So what do we do?
Well, it makes sense to not step right in front of the bullish train. You want to wait for the weakness to show itself before considering bearish positions. And, BY THE WAY, you should also know that bearish positions, on a long-term basis, are to be considered as "counter trend trades". That is, the long-term trend is still up. So a bearish intermediate-term trade is "counter trend".
I mention this because counter trend trades are not for everybody. They are for more aggressive traders.
But to all those aggressive traders out there, if you're savvy, then you should be creating a shopping list of the sectors to be bearish on when we do get that nice stock market correction. We look to the sectors that have been showing more and more weakness as the stock market has been showing more and more strength. Are you ready?
The 3 sectors on my bearish shopping list SO FAR, are:
- The Retailing Sector
- The Electric Utility Sector
- The Software Sector
Answer: They are very likely to trade down by a greater amount than the general stock market. And if the market turns around and trades higher again, these sectors are less likely to participate as much.
The Retailing and Electric Utility sectors both have supply in control. You can see this by looking at the sector Bullish Percent Indices, which show the percentage of stocks within the sectors that are on buy signals. More and more stocks within the sectors have been moving to sell signals.
The Software sector Bullish Percent Index currently shows demand still in control.
But all 3 sectors have been losing strength when compared to all other sectors. In my "TAM Tools" package is something called a sector relative strength matrix. Long story short, it divides the market into 45 sectors and ranks each individual sector against each of the other 44 sectors by performance.
For instance, the sector that has had the very best performance when compared to that of the other 44 sectors will be ranked #1. The sector that's performed better than all other sectors except the one ranked #1 is ranked #2. (Duh).
But then we take it a step further. We create a chart of the ranking history of each sector. So if a sector has a ranking of 24 (out of 45) and the ranking then drops to 26, 29, 32, 41, etc., you'll see the chart gradually declining.
All three of the sectors mentioned above have shown sharply declining "Relative Strength Matrix History" charts. There are other reasons why I think these sectors will be great bearish candidates (when the general market starts to crack), but I'll leave it there for today.
Now, at some point the market will turn bearish and these sectors will be in play. Many people reading this will find ways to take bearish positions in these sectors. But I want to be up front here about something...
There's something going on behind the scenes, and those of you who are paying subscribers to any of our services either already know about it, or will learn of it over the next week. This "something" will preclude me from following up on this article in terms of when to exit the bearish trade.
There was a debate, internally, if I should share this information about the weakness of these 3 sectors. I figured, however, it was more important that I help some of you traders out there to build a bearish shopping list for when the market does turn.
Again, there's something I am putting together, mainly for paying subscribers of IFII programs. Since I will owe it to them to give the exit timing and strategy for these 3 plays, it's not something I can make available to everyone.
But keep these 3 sectors on your radar, and, when the market cracks, these are 3 that are likely to decline the most relative to the risk of these sectors advancing sharply. (In other words, there are other sectors that will decline, perhaps sharply. But those sectors might also advance sharply on a rebound. The 3 I mentioned have reduced risk of danger of advancing sharply, thus hurting those who are bearish on them.)
The stock market looks like it has some more strength before making a bearish correction. Be sure not to jump in too early, because "overbought doesn't mean over" and "markets can stay irrational longer than you can stay solvent."
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An internationally respected authority on options, 9-year Wall Street veteran, and co-founder of Institute for Individual Investors, Chris Rowe spun out profitable trades for his Trend Rider members for 7 years, ending with his retirement in 2012. While most professionals consider an options trader who is right on 3 of 10 trades to be very good, Chris was right on the majority of his trades! Now, through his weekly "Technical Tuesday" Tycoon Report articles, Chris Rowe helps hundreds of thousands of investors across the globe, demonstrating the benefits they'll realize by taking a dispassionate, business-like approach to both stock and options trading. In his thorough and detailed, yet easy and accessible courses, you'll learn directly from Chris how incredibly easy it is to consistently make money - in bull markets, bear markets and flat markets - when you use a proven system for trading success. |
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