3 Key Signs Of A Market Top

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Every time the direction of a stock changes course, so does the financial fate of investors. Whether it's a rise or a fall, there are ways to see the changes coming and there are ways to profit from the corrections. There are a few key factors to search for when trying to predict the course of a stock, and surprisingly, you don't need a finance degree to puzzle it out.

Key No.1: Find Lows in the Highs

Markets are dynamic and as such, the chance of picking an exact top (or bottom) is unlikely and also not required in order to profit from the markets. Capturing the bulk of a trending move will provide substantial reward; therefore, there's no need to try to squeeze out every penny. Such attempts will likely result in the trader hanging on for too long, and then giving up profits when panic selling kicks in.

An early indicator for spotting a trending move is when the number of 52-week highs begins to decline, despite growth in indexes. This indicates that fewer stocks are working to push the market higher. This may be a hint that investors are less optimistic in the market and a large correction could soon occur. This first signal is often present before a top is made.

Key No.2: Advance/Decline Is Falling Down

Knowing that we will not be able to pinpoint the exact top (whether it be price or time) a trader can take profits when the market begins to show signs of weakness. Even if the market continues to rise for a time, they can take comfort in knowing the signs of correction were there, and that exiting was the prudent thing to do.

A prominent sign of a correction is the movement of the New York Stock Exchange's advance/decline line. When the NYSE advance/decline has peaked and begins to decline, despite growth or balance from the S&P and Dow, you can infer that while the selective market indexes are moving higher, the broader market is struggling. Just like a decline in 52-week highs, this indicator is often present before a top is made.

Key No.3: Major Indexes Reach New Low

The most telling sign of a market top is when the major indexes move below a prior swing low. This is the ultimate confirmation of trouble. In an uptrend, prices make higher highs and higher lows. Therefore, when prices fail to make higher highs, or create a lower low than the previous low in the uptrend, the uptrend has failed. The daily or weekly chart is commonly used, but the time frame can be adjusted to reflect the individual investor's time horizon. Unlike the first two indicators, this signal doesn't present itself until the top is established.

The Bottom Line
When euphoria is gripping the markets it can be hard to stand back from the frenzy and see that things may be heading for a reversal. This is why vigilant investors must dismiss emotions and remain focused on what the market is saying. A rising market will eventually correct and there are often early warning signs before the fall occurs. An investor who is aware of these signs can take profits in a rising market and then be on the sidelines for the correction, waiting patiently for prices to rise again.

Remain Focused

When euphoria is gripping the markets it can be hard to stand back from the frenzy and see that things may be heading for a reversal. This is why vigilant investors must dismiss emotions and remain focused on what the market is saying. A rising market will eventually correct and there are often early warning signs before the fall occurs. An investor who is aware of these signs can take profits in a rising market and then be on the sidelines for the correction, waiting patiently for prices to rise again.

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