Since February equities have rallied an astounding 16%.  Want to stick with the trend but fearful of a pullback?  There will be warnings signs.  Here is a summary of indicators / areas to watch:

1.       IWM – Small Caps often lead equities, and they certainly have done so in 2016.  Since the Feb low IWM is +25% vs SPY +16%.  So, it is important to keep an eye on this group because they may provide clues for the next market direction.  Currently, Small Caps are in an uptrend, but the next test or area of resistance in IWM is $120.40. If IWM stalls or fails at this level, the SPX may be next.

IWM – iShares Russell 2000 ETF

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Source: ThinkorSwim

2. The RSI IndicatorRelative Strength Index is a momentum oscillator that measures the speed and change of price movements.  Generally, a reading > 70 is overbought.  This is important because under normal market conditions, the major index ETFs (SPY, QQQ, IWM, DIA) do not stay overbought / oversold for long.  Note, the IWM ETF just entered overbought territory, with a reading of 70.

3. Volume –will provide a warning signal.  Currently we are in a very low volume environment.  This is usually the case in an uptrend.  However, when a change is coming the volume will rise.  In the last two market corrections, volume confirmed the change in trend (see below).

SPY – SPDR S&P 500 ETF Trust

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Source: Bloomberg

4. Option Order flow – Since the last equity turn higher back on May 24th, the equity put/call ratio has averaged 59% vs 71% over the last year.  What does this mean?  Recently, there has been very little put buying.  This is an observation that we have also noticed in the Tribeca Trade Room that I run.  The traders in the room have noticed an elevated amount of high conviction call buyers, and very little put buying.  Once this changes, volatility will return

5. The Baltic Dry Index – This index is a leading indicator for the global economy.  Equites and the Baltic Dry Index typically confirm one another. If the Baltic Dry Index takes a sudden drop in the future, a correction in the stock market may be on its way…note the index has been moving sideways over the last month.

The bottom line: Equities have had a powerful rally since February.  As always the trend is your friend but keep an eye on the above indicators to help spot a correction or a pause in trend.

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