A warning sign for stocks

In a classic example of herding behaviour, small investors have become very bullish on stocks. That could signal a turning point for the markets, says John C Burford.

Many think that summer is a bad time for stocks. "Sell in May and go away, don't come back till St Leger Day", as they say.

Although this was pretty good advice in many years before the great crash of 2008, since then stocks have actually risen in the summer months in every year of the past four, except in 2011.

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So this particular trading rule has absolutely no value to me, based on its historical performance.

For a swing trader, there are opportunities at all times of the year. And currently, there appears to be an interesting situation developing in stocks.

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Interesting situation in the Dow

This brings up an interesting question regarding the Elliott wave count.

I have been using the following count off the November 2012 low:

13-07-15-MWT01

From the wave 3 high on 22 May, wave 4 has declined in a clear A-B-C. So far - textbook.

And from the wave 4 low on 24 June, the rally is my wave 5 a final wave before the big decline sets in. And this 5 wave top should exceed the 3 wave top.

That is the roadmap I'll be using until I'm proven wrong.

But the question is this: has this final thrust done enough to call the end to this fifth wave? The closing high has exceeded the wave 3 closing high all right, but the absolute high of 15,540 has not yet been beaten.

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The jury is still out on that, as there are no clear-cut rules in Elliott Wave theory to help decide.

But I have a further clue to help me.

What form should this final wave 5 take? Ideally, it too, should contain a clear five-wave form. Let's examine this final wave 5 in detail.

Here is the hourly chart from the 3 July low:

13-07-15-MWT02

And I have drawn some impressive tramlines. My central tramline sports great touch points and several prior pivot points.

These are very reliable tramlines, so far.

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Of course, a break below the lower tramline would be negative for the rally, but so long as this does not occur, the next target will be my central tramline in the 15,600 15,750 region.

This sets up the likely Elliott wave labels here:

13-07-15-MWT03

If the market can make it to the centre tramline, that should be wave 3 of the final wave 5 from the June low.

Then, a dip in wave 4 and finally, a new thrust up into new high ground for the final fifth wave, as shown, perhaps to my highest tramline in the 15,800 region.

That will be my roadmap for now. But I will watch carefully for a lower tramline break.

Herding in action?

Non-commercialCommercialTotalNon-reportable positions
longshortspreadslongshortlongshortlongshort
$5 X DJIA INDEXOpen interest: 115,832
Commitments
43,6827,97655146,34883,99090,58192,51715,09913,163
Changes from 2/7/13 (Change in open interest: 11,573)
5,2553,669815,0106,48110,34610,2311,2271,342
Percent of open in terest for each category of traders
41.37.50.543.979.585.787.514.312.5
Number of traders in each category (Total traders: 98)
3217533226940

But ominously the small investor has suddenly become very bullish, after generally distrusting the four-year rally. The pros have been wildly bullish, while retail investors have been mostly neutral in the past four years.

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Here is the latest AAII data:

BullsBearsNeutral
49% (up 7% on week)18% (down 6%)33%
Long-term average39%30%31%

This is classic herding in action.

And this is what occurs at big market tops and why monitoring sentiment data such as this can help you pinpoint turns.

And using my tramline method can give you an edge in your timing a most essential component of successful trading.

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