Saturday, November 6, 2010

Are the markets overbought here?

With the markets making highs for the year on Friday, it was but natural that there was a lot of talk of the markets being overbought on the blogosphere and twitter. But are the markets really overbought here? Time to turn to our trusty ol' McClellan Oscillator. Following are the two year charts of NASDAQ and NYSE McClellan Oscillators with the overbought levels marked on them. 

As we can see from the charts above, the markets are certainly NOT overbought here.

It is important to realize what the above statement actually means. Does this mean that the market will continue going up until we reach the overbought levels? Absolutely not! There is no indicator out there that will tell you how the market will perform tomorrow. Maybe we start a pullback from Monday itself. All this indicator and many others like it tell you is whether the odds favor the bulls or bears right now.

What I like to do once the market reaches overbought levels is lock in partial profits and if I want to enter new longs, take smaller positions and keep tighter stop loss points. And if I do want to short, it is best to scale slowly into the short position rather than take a position all at once as an overbought market can easily become "more overbought" just like an oversold market can easily become "more oversold". But according to the above charts, it is not the time to do the above just yet! And please remember, shorting the markets just because we are at new highs or that the market has come up too much too fast is absolutely no reason to short.

I will be back with a watchlist for next week. Take care and good luck!

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