I have often said that traders and investors have a short term memory when it comes to the stock market.
Right now we are seeing signs that the same mistakes that led to the 2008 and 2001 market crash are being repeated.
Take a look at this chart:
The above chart shows the levels of margin debt (how much investors are borrowing to invest) against the S&P 500 index.
Notice how the debt levels are higher and worse than they were back in 2007 and 2000 – just before the market crashed…
Last year in October I warned that margin debt levels were too high and that it was the first sign of a major crash in the second half of 2014. This year the situation has not changed and just got worse.
Let’s remember why this is happening.
People who feel they “missed out” on the stock rally that started in 2009 (because they were scared of stocks) are finally feeling brave to buy stocks. Also, “mom” and “pop” investors who are getting tired of seeing no returns on their savings are also piling into stocks.
We also know that in a bull market investors tend to forget about the risks and over-leverage their positions. This of course gets very ugly once the market turns, thus putting these guys into margin calls and losses.
So what does this high level of margin debt really mean?
Well, what it does NOT mean is that we are heading for a crash immediately. In the 1980s for example, margin debt levels stayed high for years before markets crashed in 1987.
What the above chart and high margin debt levels mean is that we should be very cautious right now. It’s a danger sign – but by no means is it a signal that we will crash straightaway.
So here is how I see stocks for now. Take a look at this chart of the Nasdaq – which is the strongest market at the moment:
There is no doubt that stocks are very extended. But by no means do stocks look bearish. We are still in a strong uptrend.
I think the Nasdaq will probably come and test support at the 3635 January highs. If that level does not hold, then look for a test of 3600 (50 MA) and possibly 3575 (50% fibonacci retracement level).
I will look to establish new long positions at those levels, by scaling in at each level, with a hard stop just below the 61.8% fibonacci level at 3537.
I expect the uptrend to continue and so far traders who took my recommendation to go long the Nasdaq in early February are in profit. Now it is time to preserve those gains and be cautious.
Hope it helps and good trading! For further updates try our trading service.
Alessio Rastani is a stock market trader at www.leadingtrader.com .