Overbought, With Nary a Decline in Sight

 | Dec 08, 2011 | 7:08 AM EST  | Comments
  • Comment
  • Print Print
  • Print

Just about a month ago I took an informal poll on Real Money, when the S&P 500 was still showing a triangle pattern, asking folks whether they believed that formation would end in a break to the upside or to the downside. The vast majority of respondents were looking for a breakout to the upside. As we now know, the market underwent its usual routine of doing the unexpected, and broke down instead.

With Friday's European Union summit looming, I conducted another poll Wednesday, inquiring whether folks believed the EU would bring the bazooka or, instead, disappoint the markets. The results of this poll were pretty clear, with 65% of respondents looking for the EU to disappoint.

This is not a scientific poll, but it makes a lot of sense, doesn't it? After all, the EU hasn't brought the bazooka yet. They have in fact continually disappointed the markets. Why should this time be different?

Yet it seems every talking head on television says we should rally into year end. It's that old "chase for performance" mantra, or expectations for a "Santa Claus rally." I realize this is anecdotal, but this sort of sentiment does not sound nearly as one-sided as it did in November.

Since the market is reading as overbought, let's take a look at the last time the indices reached a maximum-overbought reading, on Oct. 18. Following this, the S&P did not make its high until Oct. 28. As you'll notice, the oscillator chopped around for several days before it headed south in a hurry. It took the stock market time to catch up, as well (red box on the chart).

Overbought/Oversold Oscillator -- NYSE

The first thing I must point out is that we don't know how high the oscillator will rise in the next two sessions. If it gets up above plus 600, you can see that will become an extreme overbought reading. If the market sees an up day Thursday because, say, the European Central Bank cuts rates, then we can expect the oscillator to scoot all the way up into that zone.

Now, note that once we see that sort of overbought reading, the market tends to back off and rally again. Since the market took off to the upside last week, we haven't really seen a down day thus far. All we have seen is five straight trading days of chopping.

If the market does rally Thursday, I would expect it to follow that by pulling back from the overbought reading, then rallying again, perhaps if the Federal Reserve pulls another rabbit out of its hat next week.

The real problem will come if the market rallies and the number of stocks making new highs continue to falter. So far this figure has lagged. If that continues to be the case, and we couple that with the overbought reading, we'll have a problem in the market. For now, it's toying with resistance and heading toward an overbought reading.


 

Overbought/Oversold Oscillator -- Nasdaq

Columnist Conversations

There were nice reversal-type candles on the weekly charts of the major indices. The DOW and the S&P forme...
A number of stocks on my watch lists are attempting to form positive candles a key support levels. I noted th...
Lang:
While last week was a day to pull the plug and contemplate where the market was headed, I waited for some conf...
Shares of TSLA have formed multiple hammer candles at a key level of support defined by: the September head an...

BEST IDEAS

REAL MONEY'S BEST IDEAS

Columnist Tweets

BROKERAGE PARTNERS

Except as otherwise indicated, quotes are delayed. Quotes delayed at least 20 minutes for all exchanges. Market Data provided by Interactive Data. Company fundamental data provided by Morningstar. Earnings and ratings provided by Zacks. Mutual fund data provided by Valueline. ETF data provided by Lipper. Powered and implemented by Interactive Data Managed Solutions.


TheStreet Ratings updates stock ratings daily. However, if no rating change occurs, the data on this page does not update. The data does update after 90 days if no rating change occurs within that time period.

IDC calculates the Market Cap for the basic symbol to include common shares only. Year-to-date mutual fund returns are calculated on a monthly basis by Value Line and posted mid-month.