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Dear Daily Crux reader, This week's interview is brief, but it could be one of the most important things you read this year. It's with Jeff Clark, editor of the S&A Short Report. Longtime readers know Jeff is one of the smartest, most successful traders in the business. We spoke with Jeff back in May when he was calling for a big, fast drop in stocks. The famous "flash crash" took place within a week. All the major stock market averages lost over 10% in just a few weeks... and many stocks lost even more. This week, Jeff issued an urgent new warning. He said another "flash crash" could be coming, and readers need to take action now to protect themselves. We sat down with Jeff to get the full story. You don't want to miss this one. Justin Brill Managing Editor, The Daily Crux www.thedailycrux.com –––––––––––––––––––––––––––––––––––––––––– The Daily Crux Sunday Interview Another "flash crash" could be just around the corner... The Daily Crux: Jeff, when we spoke back in early May you were really bearish on stocks. We know what happened next... The very same week the market plunged nearly 10% in a single day – the so-called "flash crash" on May 6 – and then continued to fall for several weeks after. We also know you turned bullish on stocks in late August, and caught most of the rally since then. So when we noticed you told subscribers this week to "get ready for another flash crash," we knew we had to sit down with you again. Can you tell us what's going on? Jeff Clark: Sure. I was looking for a rally to start off September because we were hearing nothing but bearish news. You couldn't watch CNBC or read The Wall Street Journal without seeing news about the Hindenburg Omen or calls for a market crash. Investor surveys showed almost no one was bullish. Even self-help guru Tony Robbins and billionaire Mark Cuban issued warnings to get out of the stock market. On top of that, stocks were getting severely oversold. Everyone was just way too bearish. And stocks usually don't crash when everyone is looking for it. ---------- Advertisement ---------- Secret Asset Class with 18.5% Annualized Gains Ever heard of the A.O.P.? Over the last decade, this secret asset class has beaten out REITs, Utilities, the S&P 500, the DJIA, even gold. In fact, the A.O.P. has outperformed practically every asset class on the market with average, annualized returns of 18.5%. As A.O.P. recipient Rick H. of Hingham, Mass. says, it seems "too good to be true." Click here for more information. ---------------------------------------- So everything was lining up for a rally, and that's exactly what we've seen. The major stock averages are up about 9% since September began. That's a huge rally for such a short period of time. Now, we have the exact opposite conditions... conditions that are very similar to what we saw in the weeks leading up to the "flash crash" in May. Today, investor surveys have jumped back up to high levels of bullishness... at or above where they were before the flash crash, yet stocks are still way below that level. And I haven't seen mention of a crash or Hindenburg Omen in weeks. We're also seeing some very bearish chart patterns. As I pointed out in an essay this week, the 60-minute chart of the S&P 500 – which just means we're using increments of one hour to trace out the lines on the chart to see more detail than what you see on the traditional daily chart – is tracing out what's known as a bearish rising-wedge formation. While stocks have been rising in this wedge, a momentum indicator called the moving average convergence-divergence – or MACD – has been showing divergence. This just means that while stocks are making new highs, momentum has been lagging. This is a sign the rally is losing steam and is likely to reverse. So in combination, those two facts suggest stocks are headed lower soon. But there's another fact that makes me even more concerned. There's another indicator I use, known as stochastics. It measures how overbought or oversold the market is. If it drops below 20, it means a stock or index or whatever it is you're looking at is oversold. If it rises above 80, it means the stock is overbought. Extreme readings below 20 and above 80 on the 60-minute chart can stick around for a few days at a time, but it's rare for them to remain there much longer than that without seeing some kind of reversal in the price of the stock or index. To give you an example, I mentioned earlier that the market was oversold in August. The stochastics on the S&P 500 dipped below 20 on several occasions that month. But each time they did, we soon saw at least a short-term bounce or rally in stocks. Even during the persistent stock rally we saw back in March and April when it seemed like the market was going to go up and up forever, the 60-period stochastics measurement rarely stayed overbought for more than a couple days at a time. But during the current rally, the 60-minute stochastics hit overbought levels right after it started, and stayed there for 12 straight trading days before finally turning down this week. I don't think I've ever seen that before. Editor's Note: Here's the chart Jeff was discussing... Clark: Like I told readers this week... If all of this were happening with high volume and high levels of bearish sentiment like we had back in August, then I'd have no choice but to be bullish now. But we're not seeing that at all. Even though summer's over and all the Wall Street traders are back from their vacations, the volume has stayed very low. And as I mentioned before, investors are downright giddy about stocks right now. There's no way to sugarcoat it... Things aren't looking good for stocks. The market is rallying in spite of weakening technical indicators... And without strong underlying indicators, the rally is doomed to fail eventually. The higher we go, the more dangerous it becomes. And we've all seen what happens when the market hits an air pocket and everyone runs for the exits at the same time. If you're chasing stocks higher, you're likely to regret it in the days and weeks ahead. Now, I'm obviously sticking my neck out here... Stocks have been overbought for weeks and have kept right on rallying. And it's possible they could rally even more before it's over. That's what happened earlier this year. I was bearish for weeks before the market finally turned down. It was a wild and frustrating time. But when it finally turned, we saw weeks' worth of gains evaporate in a single day. It's the same story now. Extreme overbought and oversold conditions have a habit of getting more extreme than you think they can, but eventually they turn. These types of reversals can happen suddenly and without warning. And if you don't prepare ahead of time, you won't get a low-risk opportunity to do so. We've been using these technical indicators all year and they haven't failed. The divergences always win out... It just takes a little longer than expected sometimes. Crux: How do you recommend readers prepare? Clark: Well, it obviously depends on the individual, but it could be as simple as lightening up on stocks that have rallied a great deal over the past month or two. You could also short a major index like the S&P 500, or buy an inverse ETF that rises when stocks fall. There are a ton of them out there now. My preferred way is to buy some speculative put options. The profit potential can be much greater, and you have the limited risk of options. Regardless of what you decide, you don't want to go overboard. I'm not comfortable making huge bets in either direction right now. But I think the odds favor a fast, sudden selloff, and I think buying puts now could be very profitable over the next month or two. Crux: Thanks for talking with us, Jeff. Clark: You're welcome. [Update: The Daily Crux spoke with Jeff again on Friday, to get an update on his thoughts heading into the weekend.] Crux: Jeff, we're seeing a pretty big rally today. Has this changed anything in your view? Clark: No... But it's actually presented us with a better opportunity. If you take another look at the 60-minute chart of the S&P, you'll see that stocks have rallied back up to the line where they originally broke down out of the wedge. It's a perfect example of a breakdown followed by a retest of the breakdown level. It is an ideal place to go short – or buy puts – from a risk/reward perspective. It only takes a couple more S&P points higher to plow through the wedge and breakout to the upside. So, you can use that as a type of stop loss. If that happens, simply cover your shorts or sell your puts for a small loss. On the other hand, if resistance holds, then the downside could be significant – perhaps 40-50 S&P points in a few days. So, you're risking maybe 4 or 5 points for the potential of a 40-50 point gain. Editor's Note: If you're interested in learning exactly what Jeff is recommending to make maximum profits from this situation, consider a subscription to Jeff's S&A Short Report. Readers are the first to know when Jeff spots low-risk, high-reward trades, and he teaches you everything you need to know to trade them successfully.Click here to learn more.