Stocks enter the 'Danger Zone'

SentimenTrader says the indicator is not intended as a market-timing tool, but can help investors avoid staying on the wrong side of the market for too long.

"Aggressive traders can monitor the MEC for a drop into extreme panic territory to hunt for bottom-fishing opportunities, but this must be paired with strict stop-loss strategies."

Investors are making their way through September with plenty to worry about, from higher oil prices to expectations of further interest-rate increases in the United States and Japan.

According to research firm SentimenTrader, market internals are also flashing an increasingly cautionary signal.

Its Market Environment Composite (MEC), which tracks eight indicators of market breadth and behaviour, stands at 2.

That places it in what it calls the "Danger Zone", a level historically associated with weak returns and elevated risk: "The market environment has fallen into an unhealthy state."

MEC readings of 2 to 4 points have historically produced annualised losses of 6% to 10% for the S&P 500, whereas readings of 5 to 7 were associated with annualised gains of 11% to 13%.

At the extremes of the spectrum, 0 or 1 signal extreme panic and have historically offered strong opportunities, with returns of more than 30%, while a reading of 8 points to an overheated market and often coincided with market tops.