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Differentiating Between An Irrational Market Or Strong Bull Market Trend?

 January 25, 2012 03:05 PM

These past two weeks have been tough as an options trader. Differentiating between trading an a possibly irrational market or bull market trend is sometimes very difficult to assess. We all know that the stock market can push us to extremes and then, just when we "give up" and "give in" the turn happens.

Timing is really everything.

Blow-off Top or Pull-Back?

[Related -Automating Ourselves To Unemployment]

Most traders I talk to are in one of two schools of thought right now. Either you think this is the best shorting opportunity for the next 2 years or you are convinced that we are now in a new bull trend that could take the S&P 500 well above 1,500. It's pretty much split down the middle honestly.

Whatever camp you are in there are some key stats that are glaring and cannot be brushed under the rug:

1) The VIX closed the week below 20 for the first time since last July.

[Related -Fed: Waiting For June… Or Godot?]

2) S&P 500 is three standard deviation points above its 20-day moving average.

3) AAII Sentiment is near extreme levels at 47% Bullish compared to 29% Neutral and 23% Bearish.

4) S&P 500 contract short interest has declined nearly 32% – no more short squeeze?

Stick to Your Guns (And Indicators)

Will a top come soon? Maybe (hopefully) but who the heck knows right. I know I have been getting itchy to trade more as I've been mostly in cash for nearly a month now. Not that I don't want to trade, but I think that better risk/reward ratios will come soon and I'd rather have cash on hand to make those trades.

During bull market trend's like this I find that keeping an eye on the indicators is best. They can and often stay over-bought for weeks but eventually they do break and divergence will be the early warning signals. Look for momentum indicators to drift lower even though the market will continue to move higher.



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