In This Bull Market, Don't Be a Hero

The last couple of months have witnessed the semi-violent chaos of new online traders jumping into the stock market mosh pit. This frenzy of activity was stirred into action by the better-than-expected economic news (with the exception of Friday's unemployment figures).

This market “mosh pit” has been full of violence because of the volatile back to back triple-digit up and down days. If you've ever been in a mosh pit, you know it’s very exhilarating -- at first. But then you're tossed on and trampled and it dawns on you: How do I get out of this thing? Aggressively jumping into this stock market  -- long or short  -- could be like an unsuccessful stage dive: You could end up landing on your face. Bulls and bears MUST have well-positioned stops on all longs and shorts, or they can expect a big black eye to their portfolios.

There have been some incredible bouts of volatility as day traders are swinging their long and short positions all over the place. One day the market gets tagged, but the very next day it explodes higher. When stocks are up at the open like today, it's “buy, buy, buy” as traders plug their nose, cover their eyes, and jump in. When stocks open down, the big money jumps in and it's “sell, sell, sell." Volatility always gets extreme like this at major turning points -- tops and bottoms.

The biggest and most famous bull in this bull parade has been urging on investors to “jump on this powerful bull train before it rides away." The pompoms are being waived like never before on TV as the bulls celebrate the new bull market like they're the New York Yankees after winning the World Series. Just as George Steinbrenner bought us Yankee fans another championship, Ben Bernanke has brought the bulls back from the brink by squeezing the life out of the shorts. The bulls, like the Yanks, get to feel like champions once again. However, this series -- the secular bear market that started on March 10, 2000 -- isn't over yet.

Signs of a Top Are Appearing

Rallies are happening on low volume (day traders), and selling is taking place on large volume (institutions). This is a clear sign a major top is likely forming. In an earlier article I wrote for Minyanville titled How to Spot the Top, I mentioned a head-and-shoulders top could be developing. On September 23 at 1080.15, a possible left shoulder formed. The S&P 500 then corrected to 1019.95 and held the rising 50-day moving average (DMA) perfectly, and then rallied higher. On October 21, the rally ended at 1101.36 -- the head of the head and shoulders top. In the next couple days will come the big test to see if this topping pattern can take shape. A close below the 1080 left shoulder, followed by a close below 1029.38, and the head and shoulders pattern will be complete. However, I believe it will take a close below the psychologically important 1000 level to break the back of the bulls. An ideally bearish pattern would be a big break from here and then a weak rally to a declining 50 DMA, followed by a failure to the downside.

This "break, rally, and ultimately fail" pattern is where the smart money starts to get short. You can see this pattern often when looking back at past major market tops. With today’s giant rally, it looks like this top could end with a new high made to suck the very last dollar in. (See, October 2007 Shows Us How This Rally Ends.)