Here's When You Go "All In" on the Short Side

It looked as though it was finally payday for the bears.

 

Last Tuesday, the Dow Jones Industrial Average dropped 189 points. It happened on big volume, which had been noticeably absent during every other decline over the past five months. And it happened with the Volatility Index (VIX) breaking out to the upside of its bullish falling-wedge pattern.

 

That was undeniably bearish action, and it should have kicked off the correction I and many other bearish prognosticators have been arguing is long overdue. But it wasn't meant to be.

 

The market bounced a little on Thursday. It bounced a lot on Friday, and it's all set to bounce this morning as well. All of a sudden, last Tuesday's decline is a non-event. It was a brief interruption of the bullish trend – a mere pit stop on the race track to stock market riches.

 

Despite my overwhelmingly bearish disposition, I wasn't ready to get aggressively short stocks after last Tuesday's drubbing. Perhaps it has something to do with not wanting to chase stocks lower. Or perhaps I've grown tired of warning investors of the storm clouds on the horizon... and seeing sunshine every morning.

 

Actually, it has something to do with this chart...

 

 

 

This is a daily chart of the S&P 500. It is forming a bearish rising-wedge pattern. This pattern occurs when the index forms a series of higher highs and higher lows, which is normally bullish, but the range between the highs and lows grows narrower. It's a major warning sign of a sudden reversal. But it doesn't become outright bearish until the index decisively takes out its rising support line – which, by my calculations, means a break of the August lows around 975.

 

I'm not willing to go "all in" on the short side until that happens. Yes, that's 45 points lower than where the S&P will open today. So I'll miss the exact top of the market. But there will be plenty of profit potential for short sellers on the next leg down for the market.

 

The vast majority of the time, these patterns break to the downside and they erase nearly all the gains from the beginning of the wedge. In other words, if the S&P 500 breaks below 975, then there's a very good chance stocks will be revisiting the lows of March.

 

Of course, I know that sounds ridiculous. After all, stocks have just experienced the most amazing five-month rally in decades. And virtually no one is calling for a retest of the lows.

 

Think about where we've come from, though. Back in March, we had just experienced one of the worst six-month periods in the history of the stock market, and virtually no one was calling for a rally.

 

Today, we have the exact opposite situation. And my view is completely opposite of what I was looking for back in late February and early March.

 

Go ahead and be bullish, if that's your inclination. As long as stocks stay within the wedge, the bull remains in charge of the market.

 

But if the S&P 500 breaks below 975, then look out below. It's going to get ugly real fast.

 

Best regards and good trading,

 

Jeff Clark

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