Last week, we took a look at a reason to be concerned about the intermediate and longer-term view of the stock market.
Today, we have a reason to be concerned about the short term.
Look at this chart of the bullish percent index for the S&P 500 (BPSPX)…
A bullish percent index measures the percentage of stocks in a sector or an index trading with positive technical patterns. It’s a percentage. So, it can only drop as low as zero or rally as high as 100.
Most sectors are overbought when the bullish percent index rallies above 80. Most sectors are oversold when the index dips below 20.
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But, when it comes to broad-based indexes – like the S&P 500 – which hold stocks in multiple sectors, the parameters are a little tighter. The S&P 500 is overbought when the bullish percent index climbs above 70. And it’s oversold when the BPSPX dips below 30.
Trading signals occur when the BPSPX reaches overbought or oversold levels and then reverses.
For example, the red arrows on the chart point to the four times over the past year when the BPSPX turned lower from overbought conditions – thereby generating a sell signal.
Here’s how the S&P 500 performed following the first three of those signals…
In all three cases, the S&P 500 started to decline within just a few days of the BPSPX sell signal.
The index fell 200 points in one week last November. It lost 450 points in less than one month in January. And, the S&P 500 dropped over 900 points in less than three months following the sell signal in late March.
This is important because if you take another look at the BPSPX chart, we got another sell signal on Friday. So, we’re likely to start another short-term decline as early as this week.
The stock market is likely to be lower in the weeks ahead than where it is today.
And, if you recall the monthly chart of the S&P 500 that I shared with you last Monday, a weak August will spell trouble for the stock market going into the traditionally weak months of September and October.
Traders should be careful here.
Until the BPSPX works off its current overbought condition, there’s limited upside to the stock market.
The downside could be substantial.
Best regards and good trading,
Jeff Clark
Reader Mailbag
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