The average investor has gone gaga over the potential China trade deal and the Federal Reserve becoming dovish. There is increasing talk of new highs in the stock market.
What should you do if you’re an astute investor? Let’s explore with the help of two charts.
Charts
Please click here for an annotated chart of S&P 500 ETF SPY, -0.14% which represents the S&P 500 Index SPX, -0.11%
Please click here for an annotated chart of DJIA ETF DIA, -0.03% which represents the Dow Jones Industrial Average. (This chart is unchanged from the previous publication in February.) Similar conclusions can be drawn from the charts of Nasdaq 100 ETF QQQ, +0.07% and small-cap ETF IWM, -0.47% Please note the following:
• The second chart shows that if the Dow Jones Industrial Average DJIA, -0.05% were to continue its rise at the rate shown on the chart, it would reach 30,000 on April 5, 2019. Since the publication of the chart, as expected, the pace of the increase has slowed. However, a previously bearish data point has turned positive and that is the next bullet item.
• Previously the relative strength index (RSI) was showing a negative divergence. In plain English, this meant that while the price was going higher, RSI was going lower.
• As the chart shows, RSI is now making a higher high than the last high. Also, the lows on RSI are rising.
• The foregoing is happening in the overbought zone.
In totality, this is a positive pattern and bodes well for new highs in the stock market if prices break out above the resistance zone. This is the most important point here.
• The first chart shows that the The Arora Report gave a buy signal right at the bottom on Christmas Eve.
• The first chart shows that The Arora Report portfolios were up to 61% protected before the stock market decline started.
• The first chart shows Arora’s calls prior to the Christmas Eve low that those lows were not the likely lows.
• The first chart shows that the volume is relatively low on this rally. Normally it is a negative but, paradoxically, in the present context it is a positive. The reason is that the low volume means that there has not been much conviction in this rally and institutions have not jumped aboard. This means there is plenty of fuel left to drive the market higher.
• The chart shows the resistance zone is overhead.
• The chart shows the support zone.
• After a strong rally, often the market pulls back to the support zone.
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Game changers
Investors are increasingly becoming familiar with Arora’s Second Law of Investing: No one knows with certainty what is going to happen next.
At this time, it is important to pay attention to Arora’s Third Law of Investing: Making investing and trading decisions based on probabilities is the only realistic and profitable approach.
If the China deal were announced before the March 1 deadline as originally anticipated, the probability was 70% for the market to fall on a “sell the news” reaction.
Trump changed the game with two steps. The first step was that new tariffs were not imposed on March 1. The first step gave the market optimism to look forward to the second step of the actual deal. Markets are always looking forward to what is next. Because of the two-step process, the technical picture of the market changed to a more positive one.
Also in February, investors were still looking at earnings from the last quarter and realizing that earnings growth was slowing. Such a realization would have sent the market down if a deal were announced at that time. The reason is that investors would have looked to the next item — slowing earnings growth. Now with the delay in the deal, the specter of slowing earnings growth has become lost.
The sum total of the two steps is that the probability of a pullback in a “sell the news” reaction has fallen to about 60%, but the probability of an eventual new high in the market has risen.
I was talking about Dow 30,000 when the Dow was around 16,000. At that time nobody else was talking about Dow 30,000. Subsequently, I have repeated the call several times. Please see “Here’s the case for Dow 30,000 in Trump’s first term.”
Based on what has happened since my first call for Dow 30,000, the Dow reaching 30,000 soon is not a big deal.
Money flows
Momo (momentum) crowd money flows in popular tech stocks such as Apple AAPL, -0.18% Amazon AMZN, -0.22% and Facebook FB, +2.32% continue to increase. However, smart money flows in those stocks are not supporting a straight-line-up market. To learn about money flows, please see “If you own Apple, Amazon, Facebook or AMD, look out below.”
What to do now
At The Arora Report we provide investors with a range of cash and hedges to hold in addition to stock and ETF positions. On March 1 we gave a signal to take advantage of the strength and increase cash within the hedge and cash range previously provided. The plan is to continue to book some profits taking advantage of the strength in the market while continuing to hold most long-term core positions.
In addition investors may consider focusing on short-term trades, be prepared to trade a “sell the news” reaction, buying special situations and buying based on evergreen strategies. Please see “Here’s an evergreen strategy to make money in a volatile stock market.” In summary, the market is not going to continue to go up at this rate and investors should pay attention to probabilities of various scenarios.
Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.