Two major indices hit highs this week … can it go on? … An indicator that suggests traders are preparing for more profits
If you’ve invested in the Dow or the S&P, you probably haven’t lost much sleep in the past two months.
However, if you’ve been a tech investor, you’ve likely experienced some awkward moments and you may have considered taking some chips off the table.
Below we look at all three major indices since mid-February.
While the Dow is up 5% and the S&P is up 2% (both hit all-time highs this week), the Nasdaq is still down 4% after plunging into correction territory a few weeks ago.
But this shortened week of trading has been good for tech stocks. For the entire market.
The question now, however, is whether this is just a temporary spike within a broader topping-out process in the market or whether profits will continue.
Today we’re going to look at an important piece of evidence pointing to “more profits”. We will investigate this with the help of our technical experts John Jagerson and Wade Hansen von Strategic trader.
In their securities service, John and Wade combine options, insightful technical analysis, and market history to trade the markets whether they are up, down, or sideways. This means that they often analyze all kinds of indicators, metrics, and chart patterns for clues as to where the market is headed.
In their update on Wednesday, they highlighted a key indicator that suggests traders are preparing to push the market even higher.
Let’s see what it is.
*** Forget “March Madness”, John and Wade saw “Margin” Madness
Of the Strategic trader Wednesday update:
We’re always looking for confirmation of trader sentiment on Wall Street.
If we can confirm that traders are optimistic, we will be more confident in our optimistic outlook.
On the flip side, we feel more confident about our bearish outlook when it looks like traders are getting increasingly bearish. After all, dealers drive prices …
One of our favorite ways to see how bullish traders are is to see how much money traders are borrowing to buy the stocks they are trading.
To make sure we’re all on the same page, let’s talk about margin debt.
John and Wade explain that traders can borrow up to 50% of the purchase price of a stock under Regulation T of the Federal Reserve Board.
If a stock costs $ 100, traders only need to use $ 50 of their own money to buy the stock. You can borrow the other $ 50.
This is known as a “buy on margin” and the amount borrowed is known as a “margin debt”.
Back to John and Wade:
By keeping track of the total amount of margin debt used to buy stocks, you can get a good idea of how confident traders are.
This is because confident traders tend to borrow more. Nervous dealers tend to borrow less.
Prior to this past year, it was the highest margin debt Wall Street had ever seen $ 668,940,000,000 in May 2018 according to the Financial Industry Regulatory Authority (FINRA).
That’s a lot of money.
However, by the height of the coronavirus pandemic, margin debt had fallen back to $ 479.291 billion in March 2020 as traders wanted to reduce the risk they had taken on their portfolios.
John and Wade point out that it’s easy to see why the S&P 500 fell on a bear market last year when you see hundreds of billions of dollars evaporating from the stock market.
*** So where is the margin debt today and what does that tell us about what traders expect?
Back to Strategic trader To update:
Have traders kept their risk low? Have you waited cautiously to see if the market would recover?
Ha! No, they do not have.
In fact, it was just the opposite.
Rather than carefully putting their toes back on an uptrend, traders found themselves on the biggest credit frenzy of all time.
By February 2021, traders have taken out a total of loans $ 813,680,000,000 Buy stocks.
Fig. 1 – Margin Debt Levels – Chart source: FINRA)
Yes, you see that correctly.
In less than a year, Wall Street borrowed an additional one $ 334,389,000,000 Buy stocks ($ 813,680,000,000 – $ 479,291,000,000 = $ 334,389,000,000).
For better context, let’s look at a chart below that compares Margin Debt versus the S&P 500. The red line shows the number of margin debt dealers who are using them. The blue line is the S&P.
As you can see, both S&P and margin debt have exploded from last year’s bear market.
Debt is currently at historic highs (although it is not at historic highs relative to the value of the S&P).
Source: Yardeni Research
Back to John and Wade:
Traders are incredibly optimistic about the stock market right now, putting their own money – plus a mountain of borrowed money – where their mouth is.
Now it’s important to note that FINRA releases its margin debt data a month later. So we are currently seeing the data for February.
We’ll have to wait until the last week of April to know what the March numbers look like, but we expect the current trend to continue.
*** Is this a sign of excess market?
How risky is it for traders to borrow historical amounts of money? And could it be a sign of the kind of hubris that precedes a crash?
You could make that argument. Every time investors take increased risk by increasing their margin, the potential for increased wiping increases.
However, some analysts suggest that the margins need to be seen in context. In particular, if the market is making lower highs while margins are rising, it could be a sign of trouble. However, when rising margins coincide with higher market highs, it can be a sign of upward movement.
On this point I want to reiterate that both the Dow and S&P 500 hit record highs this week and the Nasdaq is only 4% below its record.
Here is John and Wade’s take:
When we see traders adding so much margin debt, we are confident that the current uptrend still has legs.
There is also some risk associated with this amount of debt that can lead to faster sell-offs when they eventually occur. But for now We like what we see.
In conclusion, the latest tip from traders suggests that professional money is expecting further gains. Although the massive margin debt could cause pain later on, for now it looks like the markets will continue to rise.
We’ll keep you up to date here Digest.
I wish you a nice evening and a wonderful Easter weekend.