Looks Like a Another Good Bearish Set-up?

Click on Chart to Enlarge

Click on Chart to Enlarge

Today's advance pushed the end of day short-term models for both the Nasdaq and S&P 50o to overbought. The interpretation of where this is occurring relative to the larger trend is always a focus of mine since it is the objective indicator I use for blog trades and the goal is to go with the larger trend. Right now the markets are below their peaks for the rally which would suggest the trend is shifting to down. However, the last overbought signal actually registed at a price level lower than the current level. As the market advanced the indicator did not, creating the bearish divergence that led to declines last week. I always look to see whether the next trading signal is occurring below or above the previous signal to gauge trend from an indicator perspective.

While the rate and size of decline in SPY isn't large enough or fast enough for me to consider that the pattern has topped (from a market psychology view anyway), some sectors have declined enough to consider them topped and have given almost picture perfect shorting set-ups into today. RTH, SMH, and XHB are the ones that really look classic. The declines off the top were larger than other declines during the 2+ month rally and they undercut the first major support. Then they rallied up close to 50% of the decline in the last few days as the markets ran into short-term overbought areas.

In addition the Smart Money confidence indicator from Sentimentrader.com has declined both of the last 2 days and is back at its lowest levels in a couple years. It is very uncommon for the Smart Money indicator to decline 2 days in a row. I don't know how significant it is, but the last time it happened was in 2006 and it led to a 6 day modest decline, though it was not a major top.

The top chart above is the 60 min chart of QQQQ. Basically any fruther decline will create a bearish MACD cross at a lower level than the rally high, which may be indicative of a down trend beginning.

The bottom chart is the Treasury Bond indicator from Sentimentrader.com. It has hit an extremely low level which has usually been very close to bottoms in bond prices. So what does that mean for stocks? Well the stock/bond indicator has recently hit an extreme level suggesting stocks are overvalued relative to bonds. Also, while bonds and stocks do not always move in opposite directions, in recent years major peaks and bottoms in stocks have occurred opposite to peaks and bottoms in bonds. Also, the last month had seen a sharp rise in stocks and sharp drop in bonds, suggesting that this inverse relationship may still be in play.

Bottom line is that some key data have not given intermediate term sell signals (put call ratios haven't turned up, VIX still trending down), but I don't see a really good reason not to make a bearish trade entry at this time considering the recent indicator divergences and short-term overbought signals at (potentially) a lower high.

Depending on how tomorrow looks (gap down or up, and what happens in the first hour or so) I may suggest an inverse ETF trade.