Every down day brings calls of a market top. But based on a rare buy signal, there appears to be very little risk in the S&P 500 at this time.
S&P 500 Shrugs Off Japan's Plunge
On Thursday morning, traders in the United States awoke to news of a sell-off in Japan that drove the benchmark index for the country down by more than 7%. After a weak open, U.S. stock markets recovered and saw only small losses at the close. The ability to ignore bad news is generally bullish for the stock market. Although SPDR S&P 500 (NYSE: SPY) lost 0.98% last week, the market still looks strong.
One reason to be bullish is a relatively unknown indicator that seldom offers trading signals.
The economy alternates between contraction and expansion in a continuous business cycle. This cycle impacts earnings and the stock market but is of variable length, and it is impossible to know precisely where we are in the cycle. In general terms, this cycle varies in length but averages about four years.
In addition to the business cycle, there are probably other cycles at work in the market. Well-respected technical analyst Martin Pring recognized the importance of considering several cycles and developed an indicator he called Know Sure Thing (KST) to look at short-term, intermediate-term and long-term cycles. Pring wrote, "I've learned after all my years of trading that nothing is a sure thing, but the indicator does offer a good charting rendition of the economic growth path that revolves around the business cycle."
KST uses a smoothed and weighted rate of change (ROC) over three different time periods. It is calculated using weekly data and uses ROC for times as short as three weeks to as long as 104 weeks. Trade signals can be generated by adding a moving average (MA) to KST and using moving average crossovers to buy and sell. Pring recommended different MA lengths for each time frame. Right now, SPY is bullish in all three time frames.
Since SPY began trading 20 years ago, it is relatively rare to see all three KST indicators above their MAs at the same time. This buy signal occurs about 8% of the time.
Risk is unusually low when all three KST indicators are bullish. The largest intraday loss in SPY when this signal is active has been only 5.7%. The largest loss in SPY during that time period topped 57%.
With so little risk in the market, traders should continue adding to long positions in the stock market.
Recommended Trade Setup:
-- Maintain long position in SPY
-- Maintain stop-loss at $156
-- Maintain price target at $176
Time To Take Profits In Gold Shorts
Although gold is still in a long-term downtrend, in the short term, the metal is showing some signs of strength. SPDR Gold Shares (NYSE: GLD) rose 2.05% last week. On the daily chart, a double-bottom may have formed.
At the bottom of the chart is a 2-day Relative Strength Index (RSI). While RSI is usually calculated over 14 days, the two-day version is actually more useful for traders. On May 17, the two-day RSI fell to 0.4. Values below 5 are usually considered to be oversold. Because an oversold market can become more oversold, I like to wait to see RSI rise back above 5 before making a trade. That happened on May 20 and signaled an opportunity to take profits on short positions in gold.
In the past, after the two-day RSI has become so extremely oversold, a month later GLD has been higher 75% of the time. The average gain was 3.72%.
With short-term gains likely to be seen in GLD, PowerShares DB Gold Short ETN (NYSE: DGZ), an inverse fund that goes up when gold prices fall, should be sold. DGZ reversed last week after surpassing its price target of $14.80. DGZ has gained 15% in the past 10 weeks.
Only very aggressive traders should consider buying gold. My expectation is that the expected gains will only be a short-term bounce. The price target of less than 4% over the next month is not sufficient, in my opinion, to accept the risk of being long in a long-term bear market.
Recommended Trade Setup:
-- Sell DGZ at the market price
This article originally appeared on ProfitableTrading.com:
Market Outlook: Rare 'Buy' Signal Says Risk is Unusually Low Right Now