• Small-caps sink
• Momentum fizzles
• Plus: How smart are stock traders?

The market is sending out a few critical warning signals this morning… 

“But Greg,” you say. “Haven’t you been talking about a potential correction all summer? Last I checked, the market’s hitting new highs. Open your eyes, man!”

Well, you’re right.

The S&P 500 just clocked a new closing high last week, while the Dow and the Nasdaq both fell just short or their previous highs. 

But under the surface, you’ll find a few bits of evidence pointing toward lower prices. For the record, I’m not calling for a market crash. I don’t think you should sell everything you own and move to the wilderness. However, I am seeing several warning signs that could point to market weakness. 

Here are three reasons you should plan for a pullback sooner rather than later: 

1. Small-cap performance is getting even worse.

We’ve discussed small-cap underperformance before. After leading the bull higher for years, small stocks are beginning to crack…

You can see where the Russell 2000 and the S&P 500 begin to diverge back in early April. And aside from playing catch-up for a hot second back in June, small-caps have underperformed their larger cousins by a huge margin. So far this year, the S&P 500 is up more than 7%, while the Russell 2000 has dropped more than 1.6% over the same period. 

Small-cap performance is typically a good gauge of investors’ risk tolerance. That makes the flight to larger stocks a concern for the overall health of the market… 

2. Momentum is fizzling at new highs.

Sure, “the market” is making new highs. But is the big index running out of steam?

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“We are seeing some cracks in the rally more recently,” comments our redident trading expert Jonas Elmerraji. “While the S&P 500 has been moving higher since June, our momentum gauge at the bottom of the chart has been trending lower. That disconnect is known as a bearish divergence, and it’s typically a precursor to a drop in price.”

3. The market needs a “reset”.

A bull market doesn’t move up in a straight line. Stocks occasionally need to blow off some steam. But since mid-April, the S&P has churned higher without as much as a pullback…

Pullbacks help keep the market’s wall of worry intact. They shake out the loose hands and offer investors strategic buying opportunities. We haven’t seen many of those lately. Instead, the market has been clinging to the very top of its trading range. Even if you’re longer-term bullish, you want to see stocks release some of this pressure and “reset” before heading higher. 

Now, I don’t know what’s in store for stocks in the coming weeks. No one does. If we do see a pullback or a correction, I don’t know how far it will go. But I do know what you can do…

Stick to the plan we’ve discussed since earlier this summer. Keep your position sizes small and your stops tight. And stick to the mega-cap stocks that are helping the market stay afloat.

Today, a reader offers up a cruel statistic… 

“As a loyal reader (and Mensan) I want to remind you that HALF of your readers are below average!” he says.

Touché, smarty-pants. 

On a related note, I am sorry to report that Mensa rejected my application. I couldn’t find a pen and was forced to fill out the requisite information with an old crayon. They sent a note along with the rejection slip asking me not to bother filling out another one.

That’s a joke, of course. No one from Mensa has ever invited me to join…

Fortunately, the stock market doesn’t force you to fill out an IQ test to make a trade. You don’t have to be some sort of genius to learn a few basic trading rules. You just need to keep a level head and do your best to cut your losses when the market says so.

There are plenty of incredibly intelligent people who get burned by stocks every single day. They become enamored with a market theme or a stock idea… then it drops 20%. Then another 20%. Inevitably, they ride it to zero… and the genius idea that can’t lose ends up ruining them. 

They’re used to being right. After all, they’re smart! Smarter than most… 

Unfortunately, brains can’t save you from the realities of the markets. 

Just remember– you’re not smarter than the market. No one is. Luckily, it’s not about being smart. It’s about making money. 

Not sure if you’re even smart enough to book huge stock market gains? You have until tomorrow to figure it out. Click here to get started now…

[Ed. Note: Send your feedback here: rude@agorafinancial.com – and follow me on Twitter: @GregGuenthner]