Sunday, January 22, 2012

Are the markets overbought?

Well, 2012 has been great for the bulls so far and it's time to turn to our trusty old McClellan Oscillator to see if the markets are overbought here. Below are the charts of NASDAQ and NYSE McClellan Oscillators with the overbought levels marked on them.

From the above charts, it is clear that the markets have entered, or at least are very close to entering, the overbought region. Another up day and we will be well into overbought territory.

That being said, do remember that an overbought market can very easily become "more overbought" just as an oversold market can very well become "more oversold". Then how does one play overbought markets? Well, here are a few tips on playing 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. 
Take care and good luck!

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