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How to Spot and Time Stock Market Tops: A Primer for Daredevils


Trying to pick a market top is risky business, so you better be sure the charts and odds are leaning in your favor before starting to build a position.

Since the middle of April everyone seems to be building a short position in the equities market. We know picking tops or bottoms, fighting the major underlying trend, is risky business, but most individuals cannot resist.

The rush one gets when trying to pick a major top or bottom is exciting, and that's what makes it so addictive and irresistible. If you have ever nailed a market top or bottom, then you know just how much money can be made. The chemicals released in the brain during these extremely exciting times are strong enough that even the most focused traders fall victim to breaking rules and trying these types of bets/trades.

But if you are going to try to pick a top, you better be sure the charts and odds are leaning in your favor as much as possible before starting to build a position.

Below are a few charts with my analysis and thoughts overlaid; they show some of the things I look at when thinking about a countertrend trade like picking a top within a bull market.

Utility Stocks Vs. S&P 500 Index Daily Performance

The SPDR S&P 500 ETF Trust (NYSEARCA:SPY) and Utilities SPDR ETF (NYSEARCA:XLU) performance chart below clearly shows how the majority of traders move out of the slow-moving defensive stocks (XLU) and start to put their money into riskier stocks. This helps boost the broad market. I see the same thing in bonds and gold this month, which is a sign that a market top is nearing.

That being said, when a market tops, it is generally a process that takes time. Most traders think tops are a one-day event, but most of the time a top takes weeks to unfold as the upward momentum slows and the big smart-money players slowly hand off their long positions to the greedy emotion-driven traders.

Look at the chart below and notice the first red box during September and October. As you can see, it took nearly six weeks for that top to form before actually falling off. That same thing could easily happen again this time, though I do feel it will be more violent this time around.

SPY ETF Trading Chart Shows Instability and Resistance

Using simple trend line analysis, we see the equities market is trading at resistance, and sideways or lower prices are more likely in the next week or two.

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No positions in stocks mentioned.

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