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Momentum indicators flash warning for stocks

Thursday, 19 Sep 2013 | 6:34 PM ET
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Some important momentum indicators are flashing warnings after the stock market's explosive move to new highs this week.

Traders look at a plethora of signs and indicators to help guide their decisions. One particular area has to do with momentum, or whether the prevailing trend in prices will continue or is due for a reversal.

A number of these momentum indicators have reached a point that's indicative of a reversal of prevailing trends. You'll hear terms like Bollinger Bands, Relative Strength and MACD, among others. Simply put, these are statistical measures that tell a trader when prices have gone too far, too fast.

As the S&P 500 hovers near record highs, many traders are heeding some of these caution flags. Over the course of the year, we've seen near-term peaks like we're seeing now two other times. A common point between the three peaks is that these statistical indicators have shown that momentum was due for a reversal.

"From a technical perspective, the S&P is in or near overbought territory, as are several sectors such as Industrials, Consumer, Tech and Materials," said Max Breier, a senior equity derivatives trader at BMO Capital Markets.

During the market peak in early August, we saw signs that stocks were overbought. The market did eventually pull back, but not enough to be characterized as a correction. From that peak Aug. 2 to the trough Aug. 28, the S&P 500 fell 4.8 percent. From the market peak May 22 to the trough June 24, it fell 7.5 percent.

So, the average drop over those 2 occurrences was 6.2 percent. Hypothetically, if the market were to fall by that amount from the record high, that would put the S&P 500 at around 1,625. Even if the market were to pull back to that level, the longer-term uptrend would still be in place.

(Read more: Buffett: Stocks now 'more or less fairly priced')

Another noteworthy item is the number of new 52-week highs being set by S&P 500 stocks.

As of now, 26 are being set, or 25 percent of the index. Back around the August highs, we saw a similar number of new highs. We saw 187 of them before the market peak in May. Those last two surges in the number of fresh yearly highs also preceded drops in the stock market.

"The S&P is now up 23 percent year to date and has risen a whopping 36 percent since June 2012, in almost a straight line " said Matt Maley, strategist at Miller Tabak Equity. "We just think the market is getting a little ahead of itself."

The Federal Reserve shocked just about everyone in its September interest rate decision. The investing world fully expected the central bank to pull back on some of its stimulus measures, or to "taper" its bond purchases. Instead, the Fed chose to keep the bond-buying program in full effect, and markets rocketed higher.

Full stimulus measures will be here until the economy really starts showing improvement. Stocks hit a record high, but traders and investors are left wondering if the upside move can be sustained.

(Read more: Pimco's El-Erian: 'Lots of opportunities' left)

Experts will provide well-researched theories on what comes next. History may or may not be able to provide insight into the future, but some traders will look to the past for clues. And these are just a couple of the data points that are helping to provide a moment of pause.

"When you put all the pieces together, it feels like the market is at a stalemate, without any catalyst to push us in one direction or another," Breier said.

Your post-Fed playbook
The "Fast Money" traders discuss changes investors should make after the "no taper" announcement, and CNBC's Becky Quick has details about what Buffett and Moynihan say about the economy.

If you've been long during the rally, you've done well. There's no real dispute that stocks have surged since the lows of the financial crisis. Maley advises patience for his clients looking to get in on the market.

"Investors might want to buy on weakness," he said, "rather than chase the market at these levels."

To use a shopping analogy: Traders are looking at stocks right now like they'd look at buying the hot gift item of this holiday season. Those items are pricey now, but they could be on sale later. On the other hand, if you don't get them now, you may end up paying even more for them if supplies dry up.

That's why traders are taking a breather. They're thinking about whether to chase prices higher, or wait for Black Friday or clearances around Christmas.

—By CNBC's Dominic Chu. Follow him on Twitter @thedomino.

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  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

  • Sharon Epperson is CNBC's senior commodities and personal finance correspondent.

  • JeeYeon Park is a writer for CNBC.com. Follow her on Twitter: @JeeYeonParkCNBC

  • Rick Santelli joined CNBC Business News as an on-air editor in 1999, reporting live from the floor of the Chicago Board of Trade.

  • Senior Producer at CNBC's Breaking News Desk.

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