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Market Outlook: 3 Failed 'Sell' Signals Are Telling Traders to Buy

Michael J. Carr

Adding to the bullish case are all of the sell signals that have failed to work. Prices have failed to heed the Hindenburg Omen and the Titanic Syndrome, among other bearish indicators. Even when signals don't work as expected, they can still offer insights into the direction of the trend.

Failed Sell Signals Are Bullish

Jack Schwager interviewed some of the greatest traders in the world for his Market Wizards books. In later writings, he distilled some of their best ideas into trading rules. Among his rules is that "a failed signal is more reliable than the original signal."

This year, a number of sell signals have failed, and they could now be pointing toward additional gains for stocks.

SPDR S&P 500 (SPY) is up 15.3% since the beginning of the year, adding 1.27% last week. Considering just the size of the gain, it might seem like SPY is overbought. But it is important for traders to remember that overbought markets can become even more overbought.

Among the most reliable indicators for spotting market extremes is the DeMark Sequential, an indicator that looks for 13 days of strong market activity in the same direction. The idea is that a trend will be exhausted after nearly three trading weeks and a reversal should be near. This indicator is popular among market professionals and has an excellent track record.

But since the beginning of 2013, the Sequential has given sell signals twice and both were wrong. In addition to the two sell signals, a third short setup occurred when the Sequential rose to 13, but the market simply became even more overbought before a sell signal was given.

This indicator shows that three times this year, SPY became overbought and rather than reversing, it continued higher. As Schwager observed, failed signals are important to notice. When stocks move from one overbought extreme to the next, profits are made by staying long until there is a clear sign that the trend has reversed.

Recommended Trade Setup:

-- Maintain long position in SPY
-- Maintain stop-loss at $152
-- Raise short-term price target to $167

(Note: If you are worried about a market crash, you're not alone. Luckily, there is a simple way to know when the next one is coming. Check out my free report, 3 Indicators That Flash 'Sell' Before a Market Crash.)

Gold Resumes Its Downtrend

Last week, I noted that SPDR Gold Trust (GLD) was at an important resistance level. It failed to break resistance and resumed its downtrend, losing 1.73% last week. PowerShares DB Gold Short ETN (DGZ), an inverse fund that goes up when gold prices fall, gained 1.65% for the week. Traders should remain short the metals market and avoid the temptation to buy at what looks like bargain levels.

For those thinking it's time to buy gold now that it's fallen almost 25% from its highs, a look at silver's price chart could be helpful. iShares Silver Trust (SLV) is now more than 52% below its all-time high. Silver has been in a bear market for more than two years.

It is difficult to assign an intrinsic value to precious metals like gold and silver. Investors tend to buy them for emotional reasons, like protection against economic catastrophe. Traders simply view them as another market to trade, and that trading mindset has allowed for large profits in metals over the past two years.

Recommended Trade Setup:

-- Buy DGZ on pullbacks below $13.20
-- Maintain stop-loss at $12.65
-- Maintain price target at $14.60

Next Week's News

There will be a few big companies reporting earnings this week, but more than 90% of the companies in the S&P 500 have already reported. A higher-than-average 67% of them beat expectations.

Earnings for companies in the index should come in at about $25.96 (earnings are weighted according to how the company is represented in the index). In March 2012, analysts expected earnings for this quarter to reach $27.19, about 4.8% higher than where we are now. They consistently lowered their estimates, and now companies are beatings those lowered expectations. Analysts are continuing to lower estimates for next quarter and for the full years of 2013 and 2014. Based on their low estimates, the S&P 500 index is priced at attractive levels with a P/E ratio of 14.8 based on 2013 estimates and 13.2 based on 2014 estimates. Estimates will change, but for now earnings seem to support higher prices in the stock market.