You've got to play this rally like your future depends on it... because it does.
After a long, steep drop, stocks came rushing back on Friday, Feb. 12.
You see, that rally might be the beginning of another leg up in the Great Bull Market. Then again, it might just be a dead cat bounce and deadly bear trap.
Fortunately you don't need a crystal ball to know where stocks are headed.
That's because sometimes markets give clear signals about what they're doing - and where they're going.
When the markets do clue us in on their future, it's like a gift.
Here, let me unwrap this one for you.
How the Markets Are Feeling
Like all great and memorable gifts, this one comes with a sentimental card. In fact, it's packed with sentiment, and that's a great thing, because understanding how this market "feels" is critical for investors.
The predominant sentiment these days is uncertainty. The markets are nervous. Very nervous.
Everything that's happened since August 2015... the Chinese yuan devaluation, worries about slowing Chinese and global growth, the Fed's rate hike, plunging commodities prices... You name it, the market is worried sick about it.
In that context, it's easy to see why volatility is so high right now.
Not only that, but warnings are starting to flash all over - as I'll show you today in four important charts. They're not hard to read, and you can bet that every hedge fund manager, trader, and analyst on Wall Street is looking at them right now... And they're worried sick.
The Most Important Four Charts for Investors Today
Have a look at this...
The above 10-year chart of the Dow Jones Industrial Average shows how powerful the bull market up-trend (3 and 4) was.
But, after coming down and touching the up-trending channel's lower support channel line (3) in August 2015 - and then not being able to move much higher - the index just broke below its major up-trending support channel marker.
That's a dire warning. And worse, a new down-trending channel may become the major channel.
Now check this out...
The above 10-year chart of the S&P 500 looks almost exactly like the Dow chart. It's broken its major up-trending support channel line. Notice the beginning of a descending wedge pattern (lines 2 and 3) - I'll get to that in our last chart, where it will loom larger.
Let's check out the Nasdaq...
This 10-year chart of the Nasdaq Composite is essentially no different than the Dow Jones Industrial or S&P 500 charts.
That's important for two reasons...
First, the minor point: No matter how different investors think the Nasdaq is with all the FANGs and technology and biopharma darlings, the reality is that it's no different than any other market barometer.
Now comes the scary part: Correlation is dangerously high. And not just in U.S. stocks, either; correlation often approaches 90% across all global markets on some days.
That's a monster of a flashing red light. A crash anywhere can take down all markets like falling dominos.
Here's the last chart you need to see...
On a shorter-term basis, just one year, you can see the well-defined up-trending lower channel support line (3) being broken sharply.
Stocks tried to go higher but found selling pressure (resistance) when they got back above the old up-trending lower channel support line, which now is a resistance line.
Notice how the market fell and reached the same lows it made last August. That double bottom is now a major support line (1) for stocks.
Now, remember that descending wedge formation I showed you above? Here's the thing: What that tells us is the market is making lower highs and, so far, holding support.
If stocks continue to move along within that descending wedge (1 and 2), that's a major warning that there's not enough buying interest to break higher, that buyers are getting (more) worried.
If the support line of the wedge is broken, there's no telling how fast or how far stocks could fall.
That's what the market is telling us.
The Smartest Way to Trade Right Now
The rally we're experiencing is only temporary - unless the Dow stocks can get above 16,500 first, then get above 17,500.
All the indexes have to trade above the upper down-trending (resistance) lines of all the charts' down-trending channels. Otherwise stocks are just moving sideways and down.
There is a lot of room for stocks to move up within the new down-trending channels they've formed. So, playing bounces is okay - as long as you use tight stops.
The smartest way to play bounces, or luckiest way, is to try and get in as an up-move starts (in other words, don't hesitate if you think you see a rally coming).
Again, use very tight stops. I use 5% stops when I'm trying to catch these rallies. And raise your stop to where you get into positions as soon as they rally higher.
While the Dow could theoretically and technically go 1,000 points higher, for my money the risk is too high to jump in with a lot of capital.
Because nothing has changed, the same global themes, the same negative feedback loops, are all out there, I read these rallies from oversold levels as nothing more than dead cat bounces.
These kinds of rallies, big pops higher in what I see as a bear market, are dangerous.
They can be the ultimate bear trap and ruin investors. And that means these are trading markets, not solid investing markets.
So what if you missed getting in on this last rally? So what if you miss the next 10% higher (if we get there)?
There will be plenty of time to get in and ride the next Great Bull Market when it arrives.
But it's not here. We're either in no-man's land, or we're about to drop like a stone.
That's what the markets are telling us. It's right there on those charts, like a roadmap.
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As Shah said, the markets run the very real risk of collapsing before they get any better. That's generating lots of anxiety right now... but it's also handing us a phenomenal trading opportunity. Shah himself has used this kind of trade to give his readers at least six triple-digit gains this year - including one that topped 299%. Make no mistake: The next few months could be the most lucrative in stock market history... for those who know how to make this trade. Click here to learn more.
About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.