Tuesday, July 13, 2010

How overbought are the markets here?

After six consecutive days on the S&P and all the talk about overbought markets out there, I wanted to see for myself how overbought are the markets here. The regular readers of this blog know that for determining the overbought/oversold conditions, I put my faith in the McClellan Oscillator, an indicator that has served me rather well in the past, rather than the more commonly used RSI and Stochastics indicators. Without further ado, here are the results.

As you can see in the above charts, the markets are just above or barely at overbought levels. You would expect them to be more overbought after six straight days of gains, but I guess the fact that two of those days were doji days helps in keeping in market from reaching extreme overbought levels.

So, the markets are overbought. Does that mean we go short here? Absolutely not! Remember dear readers, an overbought market can easily go from overbought to "more overbought". And with the kind of earning numbers that we are getting, I certainly won't be getting short over here. My main interest is rather in seeing how quickly and aggressively and dips get bought. The following is taken from one of my earlier posts and is a general set of guidelines on how to play overbought markets.

"How to trade these overbought markets?

(1) Don't go chasing momentum stocks now. Chances are you will be left holding the bag.
(2) Take partial profits from longs and let the rest run. 
(3) Don't wait to sell at the top. Calling the top is a fool's game.
(4) If you want to go short, start with a small position. This way you can give it room to run instead of being forced to call the exact top. If the market indeed reverses, you will get plenty of chances to add to your positions later.
(5) Most importantly, keep your stops on all short positions no matter how confident you are of a pullback here. Remember, the markets can stay irrational a lot longer than you can stay solvent. The above assumes that you are rational in the first place :)."

For my take on today's action, see here.
Take care and good luck out there!

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