Opinion: A menacing pattern has revealed itself in the stock market – MarketWatch

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Prudent investors ought to pay attention to a menacing pattern developing in the stock market.

Please click here for an annotated chart.

The chart is of the Nasdaq 100 ETF QQQ, -0.38% A similar pattern can be seen in S&P 500 ETF SPY, -0.28% I picked QQQ because the pattern is more pronounced. And it contains popular stocks including Facebook FB, +0.75% Apple AAPL, -0.60% Amazon AMZN, -3.49% Netflix NFLX, +0.61% and Google GOOG, +0.03% GOOGL, -0.05%

It is important to note that in addition to the so-called FAANG stocks listed above, other popular tech stocks were also dumped. Notable examples are Nvidia NVDA, +0.78% Advanced Micro Devices AMD, -1.49% Microsoft MSFT, -0.31% Alibaba BABA, +0.54% Tesla TSLA, +0.67% and Applied Materials AMAT, -1.06%

In addition to technology stocks, popular biotech stocks such as Amgen AMGN, +0.08% Celgene CELG, -0.14% Gilead GILD, +0.03%  and Biogen BIIB, -0.86% were also unloaded.

Here are the key points from the chart linked above.

• An “outside day” was traced. That’s when the high of the day is higher than the high of the previous day, and the low of the day is lower than the low of the previous day. That is bearish.

• An outside day occurred at an all-time high. That is bearish.

• RSI, which is a momentum indicator, gave a very short-term sell signal.

• Volume was heavier than in recent days. That is bearish.

• Volume was not as heavy as prior sell-offs. That makes the pattern less bearish.

• The close was significantly above the low of the day. That makes the pattern less bearish.

Ask Arora: Nigam Arora answers your questions about investing in stocks, ETFs, bonds, gold and silver, oil and currencies. Have a question? Send it to Nigam Arora.

After the close, earnings from Amazon and Starbucks SBUX, -7.46% were disappointing. This caused a further sell-off in extended trading. At the same time, good earnings from Intel INTC, +1.49% Expedia EXPE, +2.43% and Electronic Arts EA, -0.45% were ignored. All of those stocks are in The Arora Report portfolio.

And, lastly, earnings from Goodyear GT, -10.44% and Exxon Mobil XOM, -2.77%  were disappointing.

What every investor must know

The research and testing at The Arora Report show that the traditional technical analysis no longer reliably works as described in the classical literature and as practiced by most technicians. The reason appears to be that the traditional technical patterns, support/resistance, indicators and sentiment analysis are now well-known, giving advance indications to the smarter players as to what the market participants following traditional technical analysis would do.

The smarter players take advantage of this information, sometimes acting ahead of the traditional technical signals in the direction of the predicted signals and then exiting in the order flow generated by the technical signal.

The foregoing is the reason that as the years go by, more and more technical breakouts fail, and the success rate of traditional technical analysis diminishes.

What to do now

Reproduced below is the “what to do now” section from the Morning Capsule that is provided daily to my subscribers:

“It is important for investors to look ahead and not in the rearview mirror.

“Consider continuing to hold existing positions. Based on individual risk preference, consider holding cash or Treasury bills 18%-28% and short- to medium-term hedges of 15%-25% and very short-term hedges of 15%.

“It is worth reminding you that you cannot take advantage of new upcoming opportunities if you are not holding enough cash. When adjusting hedge levels, consider adjusting partial stop quantities for stock positions (non-ETF); consider using wider stops on remaining quantities and also allowing more room for high-beta stocks. High-beta stocks are the ones that move more than the market.”

Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. All recommended positions are reviewed daily at The Arora Report.

Nigam Arora is an investor, engineer and nuclear physicist by background, has founded two Inc. 500 fastest-growing companies, is the developer of the adaptive ZYX Global Multi Asset Allocation Model and the ZYX Change Method to profit from change in trading and investing. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.

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