The stock market is on the verge of flashing a sell signal that could lead to a swift 7% decline, Fairlead’s Katie Stockton says

• The stock market is likely to flash a technical sell signal that could lead to more downside ahead, according to Fairlead Strategies.

• A loss of momentum in stocks means the S&P 500 could fall 7% to its 50-day moving average, Fairlead’s Katie Stockton said.

• “If these indications unfold at today’s close, we would see that as an impetus to reduce counter-trend exposure to U.S. equities,” Stockton said.

The stock market could fall another 7% from Friday’s close as momentum indicators are on the verge of flashing a technical sell signal, according to Fairlead Strategies’ Katie Stockton.

Stocks have already fallen 4% over the past week after the S&P 500 ran into resistance at its closely watched 200-day moving average. Now, it’s likely that the S&P 500 gravitates towards its 50-day moving average, just under the 4,000 level, according to Stockton.

“The market has suffered a significant loss of momentum that is likely to yield a MACD ‘sell’ signal today for the SPX, in addition to a bearish crossover in the weekly stochastics,” Stockton said in a Monday note to clients.

The moving-average-convergence-divergence indicator, or MACD, is a trend-following momentum indicator that technical analysts use to show the relationship between two moving averages of a security’s price. A signal line is plotted, which can function as a buy and sell signal. Stockton uses MACD to capture momentum and trend across multiple timeframes. The indicator appeals to her because it’s very black and white, generating either a buy, or a sell.

“If these indications unfold at today’s close, we would see that as an impetus to reduce counter-trend exposure to U.S. equities,” Stockton said.

Adding to Stockton’s confidence that the stock market could see a swift decline to its 50-day moving average is the fact that Wall Street’s volatility index has a lot of room to the upside before hitting resistance. The VIX is inversely correlated to the stock market and tends to rise when the stock market falls.

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“The VIX gapped up today after holding up near 20. With no resistance until ~35, a greater increase in volatility appears likely,” Stockton said. The VIX index surged 13% on Monday to above the 23 level as the S&P 500 fell nearly 2%.

The VIX tested support around 20 in recent weeks, which is seen as an all-important level that determines if systematic investment strategies will turn more risk-on towards equities. The VIX’s failure to decisively fall below the 20 level means the current period of heightened volatility is likely to linger.

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