Luke Downey
By Luke DowneyJanuary 11, 2021

3 signs a healthy market pullback is coming

It’s been a wonderful time to own stocks.

But after the huge gains in recent months… the markets are “frothy.”

As you probably know, the stock market doesn’t go up in a straight line. The momentum has to slow down after a big upward move. 

And that’s what the data is saying in the 3 charts below. 

To be clear: I am not being bearish. I’m simply pointing out that stocks are due for a breather. And market pullbacks are good… they give us an opportunity to buy lower. 

When I see an extremely overbought market, alongside mega-buying in stocks and ETFs… I start prepping my buy list. 

Let’s check out what the data says…

Markets are extremely overbought

There’s overbought and there’s extremely overbought. Based on the numbers, I think we’re in the latter situation.  

The Big Money Index (BMI) is the best gauge of the current markets. It measures Big Money going in and out of stocks. As you can see, it’s been signaling overbought for many weeks now:

Being overbought isn’t enough to signal a market pullback. Heck, markets were overbought for nearly half of 2020! 

But when stock buying reaches “epic” levels… it signals a “frothy” market.

Stock buying is signaling exuberance

The BMI is a moving average of daily buy and sell signals. It smooths out the trend and shows us what’s happening under the surface.

The chart below shows the last two years of daily BMI data. A big green bar indicates a lot of buying in a day. A red bar means more selling than buying. 

I’ve circled the mega-buying. This massive amount of buying is rarely sustainable. Here’s a zoom-in:

That big green bar on the right is a warning that we’re seeing an unsustainable amount of buying.

Let’s keep going.

ETFs see massive buying

An overbought market + huge stock buys + huge ETF buys = late stage buying. In other words, we’re seeing an extreme amount of buying… so much that we’re likely to see a pullback once the buying starts to fade. 

One of my favorite extreme indicators is the MAPsignals Big Money ETF Index.

Like the chart above, green bars show huge buying. Large red bars show big selling. I’ve circled last week’s action:

Together, these 3 pieces of information tell me to expect a blow-off top soon: 

  • Extremely overbought Big Money Index
  • Extreme buying in stocks
  • Extreme buying in ETFs

If you want to hear more about my thoughts on what’s ahead, I went into the details with Frank on last week’s podcast. It was a fun chat.

The bottom line: the data shows we’re likely near the end of the current uptrend. We’re likely to see a much-needed pullback in the next few weeks. This isn’t something to fear, because the long-term setup for markets is very bullish.

I’ll be using any meaningful pullback as an opportunity to buy great stocks at a discount. That’s how you stay ahead of the game.

Luke Downey
Luke Downey is editor of Curzio's The Big Money Report, which recommends the best long-term growth stocks. Luke honed his strategy over many years at Wall Street institutional derivatives desks, and as co-founder of investment research firm Mapsignals. Luke is also an options instructor with Investopedia Academy.
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