How to Prepare for a July Rally

Whoa, what a trading session! Friday sent stock prices soaring: the S&P 500 climbed 2.49% on the day, ringing the record for the single biggest daily gain of 2012. And as I write today, markets all over the world are quietly shoving higher in the first trading day of July.

Even though the S&P is looking a little bit timid today, there’s an important question on investors’ minds: “Should I buy in July?”

Today I’ll show you how the market trying to trend higher using two simple charts…

Rewind back a bit to the last time I updated you on the big picture for the market, back on June 18. Back then, I showed you a chart of the S&P 500, and explained why it was looking “bottomy”. In other words, I said that, “it looks like the market is reversing and turning higher right now.” Here’s an updated look at what Mr. Market looks like:

In the chart, I’ve labeled three horizontal price levels, 1, 2, and 3. I won’t bore you with the details of those levels here, but suffice it to say that they’re levels that act as price barriers for the S&P 500. I’ve also written in the head and shoulders labels from the column I wrote back in June.

The important thing is that from the time our head and shoulders pattern started forming, it never fell down below the right shoulder (line 1). Because the market held up above that level, we knew that our upside pattern was still valid, even though the market was reversing lower. Also critical is the fact that the S&P pushed above line 3 on Friday. The fact that Mr. Market closed above that barrier means that buying pressure is strong.
That may come as a surprise to some people. Let’s not forget the context of last week’s move: the market had been sliding lower since late March, and it looked like June was going to end by pushing lower. Sentiment was bad and investors were fleeing the market in droves. That brings us to our next chart:

This chart comes from the folks at SentimenTrader. It shows trading volume in inverse ETFs. These are bearish exchange traded funds that gain in price when the market falls. As you can see from the chart, whenever inverse ETF volume has spiked above 0.5% of all U.S. exchange volume (a sign that the crowd is piling into bearish bets), it’s signaled a short-term bottom for the market.

We saw the last spike above the 0.5% level just a week or two ago. That supports our reversal call in the S&P 500 this summer…

At this point, I think it’d be a mistake to pile into stocks to fast – we’re not completely out of the woods yet. That said, the market is reversing according to the blueprint that I showed you a few weeks ago. That sets the stage for buyers to start accumulating positions right now. If you’re looking to buy right now, I would look toward the stronger sectors–such as technology names. Names in outperforming sectors have the best chance at becoming the new market leaders if stocks continue to rally.

Happy trading,

Jonas Elmerraji

How to Prepare for a July Rally was originally featured in the Penny Sleuth.

This story was originally featured on Penny Sleuth.

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