Let's talk about the upcoming overbought condition. We got a small dip midweek and then rallied again, with the S&P 500 now at the highest close in nearly six weeks. But what exactly does this overbought reading mean?
Overbought and oversold are momentum indicators. When we got oversold two weeks ago, it was a function of having been down so much it simply gets harder to keep going down with any oomph.
And then if a spark helps a rally, that helps push us up. Remember I had said I had no idea what news might spark a rally? Yet somehow, some way we often get some news to fit the indicators.
That particular oversold condition came with some pretty bearish sentiment. This overbought reading doesn't arrive with a laundry list of folks dying to jump on board the rally-train.
As I have noted this week, we saw some of the sentiment indicators take the edge off the bearishness as folks eased up on the negativity, but we are far from complacent in my view.
If we look at the chart below of the Overbought/Oversold Oscillator for the New York Stock Exchange and we start with Box A, we can see the overbought reading gave way to a week of choppiness in the market (the brown line is the S&P) as the Oscillator worked off the overbought reading (blue line). When the Oscillator moved back to oversold, we rallied again.
That rally took us to another overbought reading in Box B, where we mostly went sideways and then rallied to a new high. You can see that move - the unsustainable one - over 2900 on the chart. But it was that lower high for the Oscillator in Box B that was really the culprit. That was a big negative divergence, showing no momentum on that new high in the S&P. Down we came.
The red arrow in early December is similar, as we had the overbought reading off the early November rally, but the late November rally saw the Oscillator barely get over the zero line. Down we went.
We'll leave the big overbought reading off the December low for a discussion another time, because it is different than the others. Point C was late February, another overbought reading that led to a pullback that took the Oscillator to an oversold condition and then a renewed rally.
Point D was another overbought reading that saw the market go sideways for a week before that last push up. Do you see point E where once again the Oscillator could barely lift itself? Down we went.
It doesn't always work that neatly - although it should - but see that this coming overbought reading will not be one of those lower high ones, or at least not a significantly lower high one. For now, I expect it to act like the others that are similar to it: either a pullback or sideways digestion, but not a collapse.
I don't expect a collapse, because the McClellan Summation Index is still heading upward. The 30-day moving average of the advance/decline line is not overbought. The cumulative advance/decline line just made a new high, too.
And finally the 10-day moving average of the put/call ratio has come down quite a bit. It has not yet pushed under 90%, which is usually when we start to think there is too much complacency out there.