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The S&P 500 index has been on a tear. It just had the best Januray since 1997. And it seems nothing can stop stocks from rising. But now it’s the time to start being careful. The index is approaching the critical level around 1,350. We will likely see a correction around that level. Take a look at the chart below.

Last year, the S&P 500 completed a Head and Shoulders pattern that indicated stocks would move lower. And they did. But now stocks are once again trading higher than the so called neckline of that pattern. This is a bullish signal. The level 1,300 now should act as a support, meaning that a lot of traders will be buying stocks around that level.

So how high can the stock market go from here?

My guess is the index is heading to 1,350, thanks to all the money-printing from the Fed and the ECB. But I would be extremelly careful buying stocks around that level. Last year there was a lot of selling pressure around that level, so I expect to see the same again.

It’s also important to consider that stocks are extremelly overbought, and everyone is bullish. The sentiment survey of the American Association of Individual Investors currently shows investors less bearish than at any time since late 2010. So it’s extremelly likely we will get a significant correction around 1,350.

This is important because the S&P 500 and the dollar are moving in different direction. So if stocks fall, the dollar will most likely recover a little. Since the dollar is extremelly oversold against most currencies, it’s also reasonable to assume a dollar correction.

Of course things can remain overbought for a long-time, and I would not make any bets just based on the overbought level. But keep in mind that 1,350 is a key level. I will be looking for defensive trades if I see signs stocks are reversing around that level. And that means buying the dollar for a short-term trade.

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