Technical sell signal could lead to a 7% drop

  • According to Fairlead Strategies, the stock market is likely to send a technical sell signal that could lead to more downside effects.
  • A loss of momentum in stocks means the S&P 500 could fall 7% from its 50-day moving average, Fairlead’s Katie Stockton said.
  • “If these indications unfold towards the end of today, we would see that as an incentive to reduce exposure to countertrends in US equities,” Stockton said.

The stock market could fall another 7% from Friday’s close as momentum indicators are about to send a technical sell signal, according to Katie Stockton of Fairlead Strategies.

Shares have already fallen 4% in the past week after the S&P 500 encountered resistance at the closely monitored 200-day moving average. Now, the S&P 500 is likely to move towards its 50-day moving average, just below the 4,000 level, according to Stockton.

“The market has suffered a significant loss of momentum that is likely to provide a MACD ‘sell’ signal for the SPX today, in addition to a bearish crossover in weekly stochastics,” Stockton said in a Monday note to customers.

The moving average convergence divergence indicator, or MACD, is a trend-following momentum indicator that technical analysts use to show the relationship between two moving averages of a security’s price. A signal line is plotted that can act as a buy and sell signal. Stockton uses MACD to capture momentum and trend across multiple time frames. The indicator appeals to her because it is very black and white and generates a buy or a sell.

“If these indications unfold towards the end of today, we would see that as an incentive to reduce exposure to countertrends in US equities,” Stockton said.

What boosts Stockton’s confidence that the stock market could see a rapid decline to its 50-day moving average is the fact that Wall Street’s volatility index has a lot of room to move upward before hitting resistance. The VIX is inversely correlated with the stock market and tends to rise when the stock market falls.

“The VIX rose today after holding close to 20. With no resistance to ~35, a larger increase in volatility seems likely,” Stockton said. The VIX index rose 13% to above the 23 level on Monday, while the S&P 500 fell nearly 2%.

The VIX has tested about 20 support in recent weeks, which is seen as an extremely important level that determines whether systematic investment strategies will take more risk relative to stocks. The failure of the VIX to definitively move below the 20 level means that the current period of heightened volatility is likely to continue.

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