We first published an in-depth article on this subject at the end of July, 2016. Since that time, the market has mostly gone higher, and no significant top has formed. Since the U.S. election, especially, the market has rallied strongly. Now, having reached an overbought state, some sell signals are beginning to appear. This is a review of current conditions vis-a-vis the four major tops that were discussed in the previous article. They were the market tops in July 2014, September 2014, August 2015, and December 2015. Note that these tops are not the beginnings of bear markets (necessarily), but are tops large enough to allow significant downside profit potential for bearish traders.
Let’s begin with a summary of our previous research. In all four tops discussed in the July, 2016, article, the market did not severely break down until there were multiple sell signals in place from our indicators. That is, when $SPX is rallying – perhaps even making new all-time highs – and is accompanied only by buy signals from our indicators, it is not a good time to short the market.
Eventually, sell signals begin to appear. Depending on your appetite for risk, you may begin to establish short positions at that time, but it can be quite a bit of time (several weeks) from that stage to a complete breakdown.
The more cautious approach is to wait for all (or nearly all) of the indicators to simultaneously be on sell signals, and then watch for $SPX to violate support. Even if that violation comes intraday, it should be acted upon. That would have gotten you short for a large portion of all four declines. It would, however, also have subjected you to one false breakdown (in December, 2015). The only solace on that false breakdown was that several indicators reverted to buy signals quickly, and you could have covered without a large loss.
We rely on five basic indicators in order to make our market forecasts...
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