Entering The Red Zone

When we started providing daily updates to the Risk Assessment Meter a few months ago, we noted that the premise was that risk should be considered high when prices are too far from support to buy and too far from resistance to sell.

Indeed, last week the market broke free from its trading range and broke out to the upside. This caused us to advise taking on a long position, which has thus far proven to be the correct course of action to take.

Keep in mind, however, where the market is at in relation to longer term support and resistance levels. The long position taken last week has thus far done well, but as we will see by examining the long term view of the SPY, any additional strength here should be used as an opportunity to take profit and to start looking for good short positions again.

In the weekly view of the SPY, note that prices are just now entering into the red zone, which we would consider the area where risk of a reversal is high. Likewise, risk for short positions will decrease significantly as prices reach for extremes inside the red zone, which is measured by the area where the falling 50-week average and falling trend line come close to meeting.

An old stock market saw says that you should never short a dull market. Indeed, the market has been dull over the past few days. It's our best guess that the market will surprise shorts who jump in too early and that we will see an additional price spike as we enter earnings season that will take prices up to the 50-week average ($139.70) and potentially up to the falling trend in the $141 area.

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As noted above, we believe that prices have a good chance at spiking higher before they come back down. If indeed this occurs, use the strength to take profit on your long positions and start putting together a potential list of short positions again.