The response to my last column, which warned of an ominous pattern in charts of big technology stocks, shows that while professionals are hedged against a decline, the average investor is full of bravado.

The real question

The real question for investors is what comes next bloodbath or bliss. To find the answer, we need to take the equivalent of an X-ray of the U.S. stock market. At The Arora Report, to do the X-ray, we mostly depend on the ZYX Global Multi-Asset Allocation Model. This is an adaptive model it changes along with market conditions. The algorithms used in the model involve a large number of macro, fundamental, quantitative and technical indicators. Today I am going to expose readers to a technical indicator that is of special note at this time about big tech stocks. On Friday I wrote: Pay attention to the ominous pattern in big technology stocks.

The most useful indicator

To see this indicator, please click here for an annotated chart.

The chart shows the difference between advancing and declining issues of the Nasdaq 100 index NDX, -1.02% The popular ETF that represents Nasdaq 100 is QQQ, -0.93% The index contains popular technology stocks such as Apple AAPL, -2.94% Facebook FB, -1.67% and Nvidia NVDA, -2.14%

Here are my observations from the annotated chart.

The top pane shows candlesticks for the difference between advancing and declining issues among Nasdaq 100 stocks.

Traditionally, only the closing value is used as an input into further studies. In my three decades-plus in the markets, I have concluded that the traditional way often gives misleading results.

To overcome the limitation of the traditional way, at The Arora Report we use an average of open, high, low and close.

The bottom pane of the chart is simply a cumulative sum of daily averages.

The cumulative sum is still in an uptrend.

The cumulative sum has its own limitations.

The middle pane shows cumulative adjusted value that overcomes some of the limitations.

The cumulative adjusted value is beginning to roll over more than the cumulative sum, but it is still above the trend line.

Ask Arora: Nigam Arora answers your questions about investing in stocks, ETFs, bonds, gold and silver, oil and currencies. Have a question? Send it to Nigam Arora.

Money flows

Investors may consider combining the difference between advancing and declining issues in the stock market or the index of their choice with money flows to gain valuable insights. To learn more about money flows, please see Four big events that are prompting investors to sell stocks and buy bonds and gold.

What to do now

This column is written for investors and not for day traders. At this time, there is no reason to panic and any dip is likely to be a buying opportunity. Having said that, the market is very overbought from a long-term perspective and valuations are stretched. Overbought markets tend to be vulnerable. Vicious selling can start at any time. Selling on Friday was nothing compared with what can happen.

For prudent investors, a defensive posture is warranted.

Here is our last call to subscribers of The Arora Report: It is important for investors to look ahead and not in the rearview mirror. Consider continuing to hold existing positions. Based on individual risk preference, consider holding cash or Treasury bills 18%-28%, short- to medium-term hedges of 15%-25% and very short-term hedges of 15%. It is worth remembering that you cannot take advantage of new upcoming opportunities if you are not holding enough cash. When adjusting hedge levels, consider adjusting partial stop quantities for stock positions (non-ETF); consider using wider stops on remaining quantities and also allowing more room for high-beta stocks. High-beta stocks are the ones that move more than the market.

Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. All recommended positions are reviewed daily at The Arora Report.

Nigam Arora is an investor, engineer and nuclear physicist by background, has founded two Inc. 500 fastest-growing companies, is the developer of the adaptive ZYX Global Multi Asset Allocation Model and the ZYX Change Method to profit from change in trading and investing. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.

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Opinion: What's next for technology stocks bloodbath or bliss? - MarketWatch