Saturday, July 20, 2013

"Overbought" stock market in the balance

Probably the most important indicator of the market’s short-term overbought or oversold condition that I track is the 20-day price oscillator for the S&P 500.  The following graph shows the 20-day oscillator to be at an “overbought” extreme and has reached virtually the same level that turned back the market’s rally the previous two times this level was reached. 

I would emphasize, however, that an overbought market condition is much less reliable as a timing tool compared to an oversold condition.  Moreover, the market can remain overbought for an extended period – sometimes weeks at a time – before pulling back.  

I’d also point out that while the 20-day oscillator is at an extreme, there was at least one instance in the last two years when the oscillator was even more overbought – back in the summer of 2011 (see above chart).  It’s possible, then, that the market could become even more overbought before the next market-wide correction.