Although the name of this column is Heating Up, I think it might be appropriate to rename it Cooling Off - at least on a temporary basis. After all, that's what I see happening now (literally) with the market, in the wake of its three-month bullish run.

As they frequently can, the indices seem to have overshot their actual value, thanks to some help from the folks who think the next three months is always going to be like the last three months. In some ways, it's not a bad philosophy - it's just a little short-sighted. Why? Because the underlying dynamic now is very different than the one we saw three months ago. In a nutshell, it's very easy to go from a low point back to a high point. Conversely, it's exceedingly difficult to go from a high point to even higher. In fact, I don't think we can...at least not immediately (although Ill be the first to confess I think Q4 is going to be bullish no matter what happens in the latter half of October).

It may be a little naïve to think there's never a price to pay for big gains. We might pay it later, eventually, but as I'm sure you've figured out, I personally think we're getting ready to pay the price now. Fortunately, it shouldn't create too much pain. However, I can also tell you it will feel just awful as we go through it, kind of like going to the dentist. Everybody seems to completely hate getting a cavity filled, but when it's done, you realize it wasn't that big of a deal. In fact, some might consider it a necessary evil with a bigger benefit at the end. In the same sense, I consider a quick correction of the recent uptrend a necessary evil...with a bigger upside for investors at the end. But we'll pontificate that point at a later time. For now, I just want to focus on why I think we're at a short-term top.

If you were reading the SmallCap Digest in June of this year, you may remember a newsletter edition titled 'So Bearish It's Actually Bullish?' On June 21st - well into the third month of this summer's downtrend - we actually made a bullish call on the market. It was not well accepted, as most readers were fairly certain stocks were going to keep falling, like they had since early May. Although we agree the trend is your friend, we also saw a clue that our friend at the time was getting ready to leave town. Were we right? Not to gloat, but yeah, we were very right....and one of the very few who were right. Between June 22nd and now (October 20th), the S&P 500 gained 9.5%, despite the overwhelming number of predictions for more gloom and doom during that time.

What did we see that others seem to have missed? Basically, a ridiculous skewing in the number of new highs and new lows. As the number of new NYSE new highs shriveled to less than 20 for most of June, and when we saw 291 NYSE new lows on June 13th, we knew the sellers were getting exhausted...those readings are about as bad as they can get. Literally, at those new high/low levels, there aren't any stocks left to sell or short. And you know what happens when things can't get any worse - they tend to start getting better. Well, they did; the market defied the downtrend with a 'darkest before dawn' quality. If you didn't read the June article, I encourage you to go back and do so, since it sets the stage for today's observation.

As of now, it appears we're facing the exact opposite scenario, which of course would be bearish. New highs are through the roof, and new lows are nowhere to be found. Just for the sake of diversifying the tools we use, let's use NASDAQ new high and new low data. The application and interpretation is the same, although what qualifies as an 'extreme' reading may differ slightly than the parameters we used for the NYSE data.

On the nearby weekly chart, we've plotted the NASDAQ Composite, its new highs in green, and its new lows in red. After a brief glance, the current problem becomes clear - the current levels of new highs and new lows are consistent with a short-term top, as we've seen since 2004. Anytime new lows sink to 13 or lower, and anytime new highs reach above 200, a market pullback is usually in the works. This week, we saw new lows dip to 9, and new highs peaked at 210. Hence, now may be the time we finally pay the price for the gains I mentioned above.

One nuance I've noticed - these signals work best when both the new high and new low readings are both simultaneously at the extreme ends of the spectrum. September's new low reading of 10 could have signaled a short-term top, but we only saw the new high figure hit 64 then, which wasn't nearly enough new highs to suggest a last gasp for the buyers. Now the new low reading just hit 9, and the new high reading just hit 210. With both data sets out of their typical 'normal' zone (dashed lines), the current situation is more in tune with historical tops, which are marked on the chart with red 'down' arrows.

The green 'up' arrows represent bottoms signaled by new lows above 200, and new highs below 13. So, the converse bullish signal works as well for the NASDAQ as it does for the S&P 500.

The prudent caveats....

This isn't a sure thing. It's a very, very likely thing, with incredibly favorable odds consistently verified by history. But when it's all said and done, it's just an educated guess. For the record - and for full disclosure - I intend to play these odds somehow, probably with index put options. While I have faith in the historical results, I'm not getting married to the idea. If somehow the market can keep going higher, I fully intend to cut bait early.

One more thing - keep in mind I used a weekly chart. It may take weeks for any downtrend to materialize. Or, the downtrend may only last week, if it materializes at all. Historically, pullbacks marked by the new highs and new lows lasted a while, but I'd say don't get a particular timeframe or size of move pre-determined in your head.