Indications of a Market Pull Back

Today, you can find many articles warning of an imminent market pull back. As a new investor, it is helpful to understand how the various indicators contribute to these forecasts so that you will be forewarned and can make appropriate alterations to your portfolio before a bottom drops out. Those who are unprepared often pay a large penalty.

Lets first look at current events. There is a very strong correlation between these events and the near term direction of the market. This week, there were reports that the job market and service sectors are in worse shape than predicted. The Eurozone economy, which has dominated the financial press, is continuing to unravel. Debt, driven by the US government, as a percent of GDP is more than 10 times higher today than it was prior to the great collapse of the 20’s. Market fear from these events can quickly stall the economy. While our economy is so shaky, our government ignores the historical lessons of our prior recessions. Obama has just release new guidelines for federal programs that will 1) remove capital from the market, 2) encourage people with weak credit ratings back into home ownership and 3) increase business uncertainty, risk and fear. The economic stall can be associated with any random event with all these other issues bearing down.

Beside specific current events, we know that seasonality has an impact on specific stock sectors as well as the market in general. Our “Best Months to Buy” article reported that May, June, August, September and October are historically the worst months of the year to hold stock.

For many, technical indicators are hard to understand so are overlook. In fact, using these tools are quite easy as they are readily available on the web. We just need to understand what they mean. Lets look at what some of these indicators are saying about our current economy and the market.

As most of us know, the most popular market indexes are hitting record highs but with lower volume. As you may remember from our previous article, volume is the most important early warning indicator for predicting changes in demand and the direction of price.

Avid technical analysts use the MACD as one of the most accurate indicators. Today when you look at the MACD for the DOW, you will see that it is converging and heading toward a bearish crossover. This is a very strong technical indicator predicting a downturn in the market. If the two lines used for MACD continue in their path and cross over, you will find that the smart investors will quickly leave uneducated investors holding the bag.

Finally, there have been five distribution days over the last month. A distribution day is when the market has a big loss with large volume. When you have five distribution days, then these analysts specify that the market moves from a confirmed up trend to a confirmed down trend. Some stock picking companies use this one indicator as the sole tool in choosing market turns. To see a complete list of technical indicators, please click here.

In next week’s newsletter, I will write about how to adjust your portfolio when you have identified an upcoming down turn.