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The stock market just flashed a technical signal suggesting more upside ahead, but investors shouldn't chase the rally, Fairlead Strategies says

The S&P 500's upside move in recent weeks was confirmed with a minor breakout on Monday, according to Fairlead Strategies.

Traders work the floor of the New York Stock Exchange during morning trading on May 05, 2022 in New York City. Stocks opened lower this morning after closing high on Wednesday after the Federal Reserve announced an interest-rate hike by half a percentage point in an effort to further lower inflation.

The breakout suggests that the S&P 500 could jump another 4% from current levels to 4,270.But investors shouldn't chase the rally just yet as the Volatility Index shows signs of a rebound.

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The stock market's 9% surge in July extended into the first day of August, with the SP 500 confirming a minor technical breakout in Monday's trading session, according to Fairlead Strategies' Katie Stockton.

The breakout suggests the S&P 500 has at least 4% upside ahead, with the next level of resistance for the index sitting around 4,270. The S&P 500 hovered around 4,100 on Tuesday.

"Short-term momentum remains to the upside, but we expect it to wane and would not chase the rally," Stockton said in a Tuesday note to clients.

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Stockton's view that investors will get a more attractive entry point into stocks down the road is based on action in Wall Street's fear gauge, the Volatility Index. According to Stockton, the VIX is showing signs of a rebound after bouncing off of long-term trendline support. That means the current cycle of high-volatility in the stock market is still intact and likely to linger.

"Our short-term indicators have turned up, supporting a near-term increase in volatility that suggests it may be prudent to stay with existing market hedges despite the minor breakout in the S&P 500," Stockton said.

Instead of chasing the rally at current levels, Stockton said investors should look for any pullback in the market that creates a higher low "given a new weekly [moving average convergence divergence] buy signal."

Since the start of the year, the S&P 500 has been consistently making lower lows and lower highs as it trended downwards. A higher low would be a signal that the downward trend in stocks could be in the early stages of reversing, and that level would likely provide a more opportune time to buy stocks.

The S&P 500 has not yet managed to make a higher high, but is close to doing so if it decisively closes above 4,200, which is above the highs seen in June.

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