The force that has propelled the stock market rally is about to exhaust itself this week. That force is related to a short-squeeze.
Let’s explore with the help of a chart. Please click here for an annotated chart of Dow Jones Industrial Average ETF DIA, which tracks the Dow Jones Industrial Average DJIA.
Note the following:
• The chart shows that 65% of the rally is related to a short-squeeze. As of last Thursday, the S&P 500 was more than 20% higher than its mid-March low, a stunning development.
• The chart shows that many stocks and ETFs fell into the Arora buy zones when the stock market fell.
• A short-squeeze occurs when short-sellers feel compelled or are forced to buy to cover short positions.
• A short-squeeze occurs in waves. The current rally has consisted of many waves of short-squeezes.
• It is important to focus on the word “related” (as in, “related to a short-squeeze.”)
• A short-squeeze often leads to a cycle of other actions.
• As the stock market rises on a short-squeeze, the momo (momentum) crowd jumps in to buy because of the momentum to the upside. This adds to the buying.
• As the momo crowd’s buying continues, buy signals are given on many technical indicators. Then technically oriented traders jump in to buy the stock market.
• On a continued market rise, FOMO (fear of missing out) takes hold, and many investors jump in to buy without fully understanding what is really happening.
• At about this time, some mom-and-pop investors start jumping in the stock market thinking that it is all clear.
• As the market rises, short-sellers put in new “shorts” and the cycle continues.
• The most important thing about short-squeezes is that they ultimately exhaust themselves. This eliminates the artificial buying that propelled a rally in the stock market.
• Investors have said there was no warning of the coronavirus. That’s untrue. On Jan. 22, The Arora Report’s call, as shown on the chart, was that the coronavirus could cause a drop in the market. After finding that investors continued to buy stocks, I wrote on Jan. 30 that arrogance and greed among momentum investors “may prove to be dangerous for investors.” Other than a potential cure, the course of the stock market rally will depend on the behavior of “naked” investors… Read more at MarketWatch.
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