Buying Stocks Just Got a Lot Riskier

The “Santa Claus rally” started on Monday. Now, just four days later, the S&P 500 is up 7%.

What a difference a few days makes. Last Friday, Wall Street’s mood was “bah humbug.” Today, it’s all candy canes and dancing sugar plums. “The Santa Claus rally is here!” exclaim all the TV talking heads who, just last week, doubted if the chubby, bearded guy in the red suit even existed…

We knew Santa was real, and we started getting ready for his arrival last week. But now, as we glance around the room, we notice the plate of cookies is empty, except for some crumbs. The milk is half gone, and there are a few droplets sliding down the outside of the glass. Over by the fireplace, we catch a quick peek of a big, black boot just before it disappears up the chimney.

It was a nice visit – short, but enough to boost stocks by 7%. And there’s still room for a little more action to the upside. But we’re starting to see the signs that Santa is on his way out.

For example, take a look at this chart of the Volatility Index (the “VIX”) plotted against its Bollinger Bands…

Bollinger Bands measure the most probable trading range for a stock or an index. When the VIX bumps into one of the Bollinger Bands, it indicates an extreme move and a condition that is ripe for a reversal in the other direction.

The blue arrows point to the few times this year when the VIX dropped down toward its lower Bollinger Band. Each of the previous three occasions marked an important short-term top for the stock market. Stocks fell 7% after the peak in April, 16% after the July top, and 10% following the peak in October.

Today, the Volatility Index is once again pressing down on its lower Bollinger Band. This is a warning sign for anyone getting too excited about the prospects of a Santa Claus rally.

Santa has already been here. If you weren’t ready for him last week, it’s too late. Don’t start looking for him today. There’s still a little more room left for the stock market rally to continue… But the risk is much higher now than it was just a few days ago.

If you bought on Monday, you have a tidy profit… and it makes sense to take some of it off the table here. If you missed the move, be patient. You’ll get another chance to buy when the VIX reverses toward the upper Bollinger Band again.

Who knows? The way this market is flopping back and forth, we just might get two visits from Santa this year.

Best regards and good trading,

Jeff Clark

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About the Author: The Growth Stock Wire

Jeff Clark is the editor of The Short Report, an investment advisory that finds extremely overpriced securities set for a sudden fall. Clark is the former president and chief executive officer of an independent, San Francisco-based brokerage house, and the founder of an investor education firm. Jeff has served as a consultant to one of the country's largest options market-making firms, and he has also developed the curricula for an international Masters of Business Administration (MBA) program.

This year, Jeff started another research service called Advanced Income, a research service focused on providing a steady stream of high income payments. Using his techniques he can show you how to pocket thousands of extra dollars in the next 24 hours, no matter what happens in the stock market.