For the past month or so, I have been watching a particular indicator more closely than usual anticipating that it was going to break a threshold I consider to be a bearish sign.
The indicator I am referring to is the Investors Intelligence report, and the threshold I have been expecting it to break was the 2.5 ratio.
Last week’s report did just that, as the bullish percentage jumped to 54.7 percent, but the bigger move came from the bearish side of the equation, as the bearish percentage dropped to 21.1 percent.
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This gives us a ratio of 2.59 bulls for every bear and historically when this ratio moves over 2.5, the market experiences a pullback within a few months.
While I remain bullish for the long term, this development has caused me to change my intermediate-term outlook to bearish.
While I wouldn’t recommend rushing out and selling everything in your portfolio, I would recommend taking some action to protect your portfolio.
You could take some profits off the table and add to your cash position. You could buy an inverse exchange-traded fund (ETF) as a hedge for the rest of your portfolio. Or if you are comfortable using options, you can buy puts on one of the ETFs that track the major indices.
The market is extremely overbought on both its weekly and monthly charts, and with the sentiment indicators hitting extreme levels of optimism, investors should take action to protect against a sizable pullback.
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