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The Stock Market Takes a Reality Check

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Two weeks ago stock market expectations were high with no imminent weakness apparent, everyone cheered as the Dow hit the headlines by making a new all-time high. But when exuberance and hype are abundant the irony is that stock markets will often turn down, you see stock market declines can happen when they are least expected and catch many people unaware. I could see that coming two weeks ago when I went short the S&P 500 from 1560.

So far the European markets have been hit the hardest and are tumbling. The S&P is more resilient but my well-timed short position is 10 points onside and I’m maintaining my view that the S&P will join the European march lower.

The divergence I mentioned in my last article between the S&P and the Dow Jones was the first warning shot of a potential reversal. The second warning was fired when the e-Yield Sentiment Indicator (for premium members) turned down on 28th February. When sentiment receded and the stock market continued to rise the indicator confirmed a bearish divergence and my trading alert to go short was rightly triggered.

The European financial crisis looks likely to return and kick start a new bear market into action, but the question is – has it already begun? There are early warning signs resurfacing as the people of Cyprus experience the crisis first-hand. I’m expecting contagion to other European countries and as a nod to further downside risk, I’m remaining short.

Even though I’m not anticipating any more rallies as I believe upside from here is limited, there’s still the outside chance of the S&P making a new high near 1570. However, I feel strongly about further downside potential, so to protect my position from any positive knee-jerk reactions I’m raising my stop from 1580 to 1585.

Extract from The Disciplined Trader

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