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More Upside Ahead… But Get Ready for a Reversal

Right now, the bulls have regained momentum. But storm clouds are brewing. Overbought conditions mean there’s opportunity ahead…

The bulls are running again.

The S&P 500 blasted higher yesterday. The index gained almost 27 points. That’s more than 1%. It was the biggest one-day gain in about two months. There’s no doubt the bulls have regained the momentum. The path of least resistance, in the short term, is higher.

Take a look at the daily chart of the S&P 500:

The first thing to notice about this chart is that the S&P 500 is currently trading above both the 9-day exponential moving average (EMA) and the 50-day moving average (MA). That’s bullish.

Also, the moving averages are in a bullish configuration – with the 9-day EMA trading above the 50-day MA. This also supports the prospect of higher prices in the short-term. 

Finally, the technical indicators – like the MACD momentum indicator and the Relative Strength Index (RSI) – are in neutral territory. They have plenty of room to run higher before hitting overbought conditions.

So the S&P 500 should be able to rally up to the resistance line of the “rising channel” pattern it has been in for the past several months. That gives us an upside target of about 2505 for the index.

But it’s not all lollipops and unicorns. There are some storm clouds brewing beneath the surface.

The McClellan Oscillators for the NASDAQ and the NYSE are approaching overbought levels. They’re not there yet. But another strong up-day should do the trick. Several times this year, overbought conditions on these oscillators have preceded strong one- or two-day selloffs.

Volatility Index call options that expire next week are once again trading for a large premium above the equivalent put options. This same condition preceded last Tuesday’s big drop in the stock market.

Finally, the S&P 500 closed yesterday 22 points above its 9-day EMA. The index rarely strays much more than 30 points above the 9-day EMA before coming back down and retesting the line as support. If the S&P rallies to my upside target of 2505 within the next day or two, it will be over-extended to the upside and vulnerable to dropping back down to the 9-day EMA.

So here’s the bottom line…

The momentum and the price action are clearly bullish. This should lead to slightly more upside for the stock market in the very short term – meaning the next day or two. But on a continued move higher, the market is going to generate some overbought conditions – which have previously led to strong one- or two-day pullbacks.

Traders should look to establish short positions as the S&P 500 nears the 2505 target and conditions become overbought.

Best regards and good trading,

Jeff Clark

P.S. What are your thoughts on the current condition of the market? Send me your responses, questions, and suggestions right here.

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Way to go, Jeff! Great trading, you are indeed a Master : ) Looking forward to more exceptional trades in the coming weeks!

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Thanks for the great note today, reminding us that a watched kettle does not boil.

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