What I Told “Mr Speculator” About the Stock Market Now…

Just a few days ago, I received another call from my good old friend Mr. Speculator. He was worried. He has been long on the stock market since the beginning of the year, but sadly, stocks have come down a bit. He asked, “Do you think there’s more downside on the stock market? Or is this the correction everyone was talking about?” Mr. Speculator bought exchange-traded funs (ETFs) that provide him leverage; he added, “My losses are adding up. Should I sell or wait?” 

Mr. Speculator isn’t the only one who is asking this question since the key stock indices started to come down. I hear this question being asked all around. January is supposedly a good month for stocks, but so far, this is simply not the case. The S&P 500 is down roughly three percent. Investors are asking whether or not the returns on stocks are going to be horrible this year. 

Looking at the charts and assessing the sentiment, it appears reality is slowly coming back to the stock market. Take a look at the following chart of the S&P 500.

Chart courtesy of www.StockCharts.com 

Looking from a technical analysis point of view and taking the S&P 500 as an indicator of the entire stock market, there are a few developments that investors need to know. 

First of all, since the beginning of the year, the volume on the S&P 500 has been increasing. This is interesting to note, because it suggests investors are selling into weakness. In addition to this, we see that the S&P 500 has broken below the 1,800 level and has moved below its 50-day moving average (MA). This level can act as resistance to the stock market on the way up. Finally, indicators like the MA convergence/divergence (MACD) are suggesting that momentum on the stock market looks to be in favor of the bears. 

As this has happened, we have seen increased fear in the stock market. Look at the chart below. It shows the Chicago Board Options Exchange (CBOE) Market Volatility Index (VIX). This index shows fear in the stock market, and you can see how fast it has increased in the past few trading days (circled area). It’s up more than 21% since the beginning of the year.

Chart courtesy of www.StockCharts.com 

Having said all of that, is the top in on the stock market? As I have said in these pages many times before, predicting tops and bottoms can be very dangerous to an investor’s portfolio. 

Here’s what I told Mr. Speculator: The risks to the downside seem to be increasing. Patience is key. If you have any profits, take some off the table in case the stock market quickly turns. If you have losing positions, cut your losses. Watch closely, and see where the market goes next. After having such a stellar run in 2013, the stock market needs some time to breathe.

~ by Mohammad Zulfiqar, BA 

This article was originally published at Daily Gains Letter