The market put in another strong day today with all the major indices posting new multi-year highs. There were also solid breadth numbers. This included an expansion in new highs. The NASDAQ finally posted more new highs than at its previous peaks of 10/16 and 10/26. This could be a good sign. Improved breadth may help to carry the market higher a while longer even if momentum continues to diverge.

In my last two columns I’ve discussed some reasons why I believe the markets shifting from trending to oscillating and possibly forming a top. I suggested on Monday that the best way to play an oscillating market such as this would be to play the overreactions. The market seems bent on putting my theory to the test right away as it ran up rather strongly the past two days and is starting to get overextended, though not dramatically yet. The NASDAQ and S&P did close today above their upper Bollinger Bands. Meanwhile, the VIX closed about 5% below its 10-day moving average. Still, in up trending markets, it’s difficult to know when overbought is overbought enough. Aggressive traders who believe as I do that we are entering an oscillating, rather than trending market could begin to probe, or scale-in on the short side.

Personally, I would prefer to see a gap up or move even a little higher in the next day or so before entering some on the short side, but I do expect we will see a reversion to the mean fairly soon.

When looking to trade overextended oscillationsm, a few things need to be kept in mind:

1) Respect the trend. Short trades are going against the trend as of now. They can be lucrative, but you need to play them a bit more conservatively than if you had the trend in your direction. (Buying an oversold uptrend or shorting an overbought downtrend are more reliable and potentially lucrative.) Therefore, play a little lighter and don’t overstay your welcome. Take your profits a little quicker than you would if the market was already in an established downtrend.

2) Exact timing of your entry is difficult, if not impossible. There are two ways to deal with this. You can either use reversal signals in lower time frames to time your entries, or you can utilize a plan of scaling in as the trade moves against you. What you should not do is say, “Ok, we’re overbought, time to load up on the short side”. If you’re all-in immediately and your timing is poor, you could be in for a scary ride.

Best of luck with your trading,

Rob
Rob@HannaCapital.com

For those who may be looking to expand their knowledge beyond just market timing, my Hanna ETF Money Flow System utilizes the VIX in generating trading signals for spread trades.

Rob Hanna is the principal of a money management firm located in Massachusetts. He has spent the last several years developing and refining methods for trading in stocks across multiple time frames. He selects stocks using both fundamental and technical criteria, and then trades them using technical analysis techniques.