When the stock market failed to crash, those hesitant traders jumped off the sidelines and back into the market, fueling the recent rally.
But there are just as many traders still sitting on cash, pulling their hair out as they ask: “Have I just missed out on the start of the next great rally?”
To find an answer, I dug into the inner workings of the market to get a clearer picture of what’s happening. And the picture I uncovered isn’t great…
There are few things powerful enough to predict the future, and I don’t pretend to do that. Instead, I like to look for signals in the market that help to confirm or cancel out certain moves in the market.
Today, I’m looking to confirm the broad market’s race to record highs.
Will it last or won’t it?
Last week, I mentioned I was looking for confirmation from the Dow Jones Transportation Average (and its tracking ETF, the IYT) to close at a higher high, which would be about 9,200 — this week we got that confirmation. That means this rally has a little steam and can continue for months, but there will still be ups and downs … and a down move in the market could be just around the corner.
Another indicator I follow to determine the strength in the direction of the market makes me hesitant to be bullish at the moment: the advance-decline line.
The Truth Behind the Rally
You may have heard of the advance-decline line. It is simply the difference between the total number of shares of stocks that are advancing on a particular day minus the total number of shares that declined. This number is called the advance-decline index, and investors use a one-day running average of it to determine the strength or weakness of a rally. This average line is called the advance-decline line.
Basically, investors are following peaks and troughs in the advance-decline line, expecting it to match up to the broad-market movement taking place.
For example, right now the markets are at all-time highs, yet the advance-decline line failed to rise higher than a peak set in September.
Take a look for yourself:
You can see that the latest level (far right of the chart) is below the peak in September.
That means this rally isn’t broad-based. It’s being supported by a handful of strong stocks, and there are actually more lagging stocks than we have seen in previous rallies.
Since the current rally — which is pushing stocks to record highs and fueling a euphoria-like environment — can’t be confirmed by the advance-decline line as a stronger rally, it could be foretelling a reversal is near. I’m hesitant to be bullish right now.
A trading philosophy I live by is that the market can be irrational longer than you and I can remain solvent. What that means is that even though all the signs are there for the stocks to pull back, it doesn’t mean they have to, and this rally could last months.
So we can’t have a completely bearish portfolio, or we will get wiped out.
Instead, I look at this as simply not the time to jump into the stock market.
If you have remorse for missing out on the current rally, don’t worry. When prices plunge to much lower levels in the coming months or year or so, you’ll be glad you held back on diving into the market today.
This article is brought to you courtesy of The Sovereign Investor.