1. Market averages are overbought.
Prices have moved up “potentially too far, too fast.” The SPY gained more than 4% in the two weeks before its most recent high. Gains of that size are unusual. They happen on average just a handful of times each year. And a pullback starts the following week more than 50% of the time.
Indices have a long-term upward bias. They go up more often than they go down. Signals showing prices fall more than 50% of the time are rare. That makes this signal important and worth watching.
2. SPY reached its upside target.
The SPY shows that the ETF met its price target last Thursday based upon a calculation of the uptrend that began in June. Declines lasting at least a few weeks follow this signal approximately 65% of the time.
3. Momentum turned down.
Momentum indicators measure how fast prices move. Traders look at dozens of these indicators. Analysts expect changes in momentum to lead to price reversals. Now, we can think of these indicators like a runner charging up a hill.
Nearing the top of the hill, they’re likely to slow down. This allows them to catch their breath after working so hard to move up the hill. The slowdown in momentum precedes the reversal to the downside of the hill. It appears we could’ve peaked last week and now seems like we could be cresting. Traders will react to today’s news from the Fed. That could be the catalyst for a multi week trend following a continued rise in interest rates – the highest in 22 years.
Economic news could also drive a big move. The first estimate of gross domestic product growth in the second quarter is due before the open today. The Fed’s preferred measure of inflation, the Personal Consumption Expenditures Index, is set for Friday morning. With momentum pointing down, news stories are more likely to spark a sell-off.
4. Seasonals turned bearish.
The last indicator pointing to a market reversal has to do with seasonality. Seasonal trends are found based on how prices moved in previous years. Throughout the year, there are some periods when stocks tend to rise and others when stocks tend to fall. The seasonal trend in the SPY peaked last week and future projections head lower until about October.
Like any indicator, seasonals are wrong sometimes. But they are still useful. We are at the beginning of this year’s strongest seasonal downtrend. It’s another reason to expect a pullback in stocks is on the horizon. Click here to watch my strategy in action…
