Are There Too Many Bulls?

12/24/2010 7:00 am EST

Focus: STRATEGIES

Thomas Aspray

, Professional Trader & Analyst

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Chart Analysis: The performance of the stock market over the past four months has been astounding, and even though my intermediate-term trend analysis is still positive, some warning signs remain. As of December 23, 63.3% of those polled for the American Association of Independent Investors (AAII) were bullish with only 16.4% bearish. These readings are in dramatic contrast with those from August 26, when just 21% were bullish and 49% were bearish. Also, in late August, only 30% of newsletter writers were bullish, as reported by Investors Intelligence, but as of December 14, 57% are now bullish.

The CBOE Volatility Index (VIX), after spiking to 23.8 in November, has since resumed its downtrend and is currently at 16.49. It is approaching the strong support from 2007 in the 12 area. To change the trend, the VIX would first have to move above 19 and then the 24 level to develop a pattern of higher highs and higher lows.

What It Means: Though sentiment numbers can stay at extreme levels for some time, they should always be considered as part of one’s investing or trading strategy. A drop back in the AAII numbers to below 50 would make me more comfortable. The VIX is often referred to as the "fear index" because when it is declining, it reflects a lower level of put buying and shows that there is a low level of fear in the market. This is also consistent with a low level of bearishness.

How to Profit: Trying to pick a market top is a quick way to financial disaster, though it is good to keep an eye on the risk level at all times when deciding whether to buy or sell. There are still quite a few stocks that have just come out of base formations or continuation patterns where the risk can be managed. These types of stocks or ETFs should be considered for new buying. However, if you are in a stock, ETF, or fund that is up sharply and back to major resistance, taking some profits off the table is never a bad idea.

Tom Aspray, professional trader and analyst, serves as senior editor for MoneyShow.com. The views expressed here are his own.

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