Watch out!
The stock market’s spectacular intraday reversal on Friday may turn out to be a bull trap.
Bull traps are moves designed to sucker folks back into the stock market just before another large down-draft begins. And Friday’s action had all the telltale signs of one.
Seemingly Good News
Stocks were selling off for most of Friday’s session. By midday, the S&P 500 was trading below the 5200 support level. The Volatility Index (VIX) was spiking higher – showing an increase in investor fear. It looked like the market was poised to fall off a cliff.
But then, in the final hour, we got the sort of “gamma-squeeze” we’ve seen with increasing frequency since the creation of 0DTE (zero-days-to-expiration) options (you can read up on this phenomenon in this essay).
The S&P recovered some of its losses and then bolted higher to recover all of its losses – by the end of the day it was up nearly 1%.
The buying pressure continued yesterday morning. And now, lots of folks are talking about another move to new all-time highs.
Those folks may be right. But, there is one glaring problem.
We Could Be in for a Big Decline
The Summation Index for the NYSE flipped to a sell signal last week. Take a look…
This Summation Index is another technical tool for measuring market momentum.
Whenever the NYSI rallies above its 9-day EMA (the blue line on the chart), it indicates that momentum is turning higher – and that’s usually a good time to buy stocks.
Whenever the NYSI falls below its 9-day EMA, momentum is waning. That’s usually a good time to sell.
The red lines on the chart show the sell signals over the last two years. Here’s how those sell signals lined up with the S&P 500…
Three of the four previous NYSI sell signals led to an immediate decline in the stock market. The decline last May was quite mild – just over 100 S&P points. But the declines this past April and last August were more significant.
There is no way to know if the current NYSI sell signal will lead to a small decline or a large one. Heck, it might even lead to the market just marking time for a few sessions before stocks blast higher again – like they did in January.
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So, I’m not suggesting folks liquidate all of their positions and take a full 100% short trade.
I am suggesting, however, that rather than getting caught up in the current casino-like atmosphere of the stock market, folks might want to be a bit cautious here. NYSI sell signals have a good track record.
So, until this one is negated – with the NYSI closing back above its 9-day EMA – it is possible, even likely, the bounce that started last Friday is a bull trap. Traders should approach it with caution.
Best regards and good trading,
Jeff Clark
Editor, Market Minute