The news: The market keeps grinding higher, consistently making new highs despite seemingly everyone trying (and failing) to call the market top.
How to spot the top: I use a 5-day exponential moving average and overlay it on the market. When we have a hard close below the level of the 5-period EMA, that’s when the market is likely to step back. So Thursday — when the market opened below the line but closed above it – was a fake-out.
The Relative Strength Index (RSI) – which shows the market to be way overbought — increases my confidence that a close below the 5-period EMA will do the trick. You don’t need to look at a million headlines and indicators, just wait for that hard close; until you see that signal, the Standard & Poor’s 500 will keep trending up, no matter how implausible that seems. It’s elementary but it works.
How to play it: Whenever we see the signal, put your stops in at the high; that’s nice and tight so if it doesn’t play out as expected, you stop out with a paper cut. The reward on this trade would be to see the S&P 500 – which you can play using the SPDR S&P 500 ETF (SPY) or with leveraged plays on the index — fall back to the previous resistance levels, giving you a nice risk-reward balance on the trade.
Jason Bond runs JasonBondTraining.com and is a swing trader of small-cap stocks.