RSI Dangerously Overbought for S&P 500, Dow Jones and NYSE Composite

As a standalone conventional indicator RSI can give some misleading signals. However, RSI has ventured into an overbought zone rarely attained. There are also other forces at work that suggest paying more than the usual attention.

Parents remember the famous words, “Are we there yet?” Investors are probably wondering, “Are we overbought yet?”

The S&P 500 has gone more than six months without a correction greater than 5%, so the question, “Are stocks overbought” is certainly a valid one.

The weekly bar chart below shows one of the most rudimentary momentum gauges – the Relative Strength Index (RSI).

RSI attempts to gauge the extent of ‘overboughtness’ by comparing the magnitude of recent gains to recent losses.

I prefer not to walk the ‘beaten path’ of technical indicators and use a 35-period RSI instead of the 14-period RSI default. The 35-period RSI spits out some signals that may go overlooked by the investing masses.

Here are the signals:

1) RSI is above 70 and overbought. In fact, RSI is at or near the highest level over the past decade. The dotted purple lines mark periods of similar RSI readings.

2) This week’s RSI high has confirmed this week’s new all-time high. There is no bearish divergence (most prior price highs occurred against a lower RSI reading).

Here are the conclusions:

1) Prices are likely to struggle moving higher or correct.

2) RSI (along with other momentum indicators) confirmed the latest price high, which suggests that any decline is unlikely to mark a major market top.

Here is RSI in context:

Various sentiment indicators have reached the ‘danger zone’ and post-election seasonality is about to turn sour.

The up trend is still intact and coming up with possible price targets or resistance levels is tougher for indexes that are trading at all-time highs. There simply is less overhead resistance.

For that reason, the Profit Radar Report has been recommending long positions in the Nasdaq-100 Index (corresponding ETF: PowerShares QQQ – QQQ).

The Nasdaq-100 has well-defined resistance and support levels. Thursday’s trade briefly poked above long-term trend line resistance and fell back below. This was a sell signal for half of our Nasdaq-100 position.

It is too early to tell if prices are ready for the seasonal summer siesta, but with sentiment heating up, seasonality cooling down and prices falling away from resistance, it’s prudent to take some profits off the table and prepare for the balancing act between milking the bullish potential and minimizing bearish risk.

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Weekly ETF SPY: AAPL at Crossroads

The cat is out of the bag. Everyone knows that AAPL prices are no longer linked to iPhone, iPad or other iGadget sales. To the frustration of Wall Street, AAPL has developed a mind of its own. Here’s one simple trick that foreshadowed all turns since November 2012.

Is Apple’s decline over? Much has been written about Apple’s quick demise from darling of the masses to giant under achiever.

The good news is that AAPL shares recovered a bit recently. The bad news is that further gains are a must to break the down trend. Here’s why:

Charted below is AAPL on a log scale along with RSI (Relative Strength Index) and some powerful support/resistance levels.

Apple’s decline from the September high has been confined to a well-defined parallel trend channel.

Every instance Apple hit that channel is marked with a gray circle. There are six circles, so AAPL must consider this channel to be important.

This week AAPL touched the upper channel line for three consecutive days but has so far failed to break above it.

At the same time, RSI has come back to test resistance at 51, a level that rebuffed all prior rallies since October.

There is a silver lining for AAPL bulls. On the regular (non log scale) chart, AAPL already moved above its parallel channel. Nevertheless, the down trend deserves the benefit of the doubt as long as AAPL fails to bust through price and RSI resistance.

Regardless of your bias, what AAPL reaction to current resistance will likely set the directional trend for the coming weeks. The trend channel can be used to find low-risk entry points and to manage risk.

The other shown support/resistance levels may come into play if AAPL is able to break out if its current ‘resistance prison.’

The lower ascending red trend line goes back to the year 2000. The dashed gray channel goes back to May 2010 and the upper ascending red trend line originates in 2003.

All those long-term support resistance levels have been helpful in anticipating important turns, particularly the all-time high above 700.

The September 12, 2012 Profit Radar Report featured this (at the time outrageous) trade recommendation: “Aggressive investors may short Apple (or buy puts or sell calls) above 700 or with a close below 660.

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S&P 500: Bearish RSI Divergence Waives Red Flags

The December 2, Profit Radar report predicted new recovery highs, but warned that: “Any new recovery high marked by a bearish price/RSI divergence could mark the end of this rally.” That’s exactly where we’re at now.

Research studies show that investors as a group buy high and sell low. The media fuels this kind of crowd behavior, trashing stocks near a bottom and hyping them up near the top.

The “headline index” – a fictitious index based on a not entirely worthless evaluation of media sentiment – depicts a media more cheery than any other time in 2012. The upside is limited whenever the media is implying a sustainable rally.

But this article isn’t about sentiment or the media; it’s about a technical divergence. One that incidentally runs contrary to the media’s blissful mood.

RSI Basics

The Relative Strength Index (RSI) is a very basic and commonly used momentum indicator. I usually don’t subscribe to popular indicators (the more folks use any given indicator the less effective it is), but RSI just happens to work very well for me (perhaps because I use an unusual setting to make it more ‘special’).

My simple theory is to look for unconfirmed highs or lows. Any new price high/low unconfirmed by a new RSI high/low is a bearish/bullish divergence. This theory works at multiple time frames. I like to use it for spotting highs/lows that last for weeks or months.

This simple strategy has helped me to identify the May 2011 top and October 2011 and June 2012 lows.

Bearish RSI Divergence

The chart below is visual evidence that every bigger top since 2010 (vertical dashed red lines) sported a bearish RSI divergence (new price high without new RSI high).

The September 14 high fooled me, because there was no bearish divergence (dashed green line). Due to the lack of divergence, I refused to abandon my outlook for new recovery highs above 1,475, which at the time was quite unpopular.

Via the September 30, Profit Radar update I stated that: “The September 14 recovery highs for the S&P, Dow, Russell 2000, and XLF were all accompanied by new RSI highs. It would be rare for stocks to form a long-term peak without a bearish price/RSI divergence. Because of this lack of divergence we expect new recovery highs.”

The December 2, Profit Radar update again noted that: “The decline from September 14 – November 16 was a correction on the S&P’s journey to new recovery highs. This scenario is supported by the lack of bearish price/RSI divergences at the September 14 high, continuous QE liquidity, and bullish seasonality. There is no specific target, but any new recovery high marked by a bearish price/RSI divergence could mark the end of this rally.”

Something’s Changed

As of last week, the S&P 500 recorded new recovery highs above 1,475 void of a new RSI high. In itself, that’s not a sell signal, but it’s a red flag.

As with any indicator, RSI divergences become more potent when confirmed by other technical indicators or support/resistance levels.

I was excited to discover two important resistance levels not far above current trade. In fact, one of the resistance levels caused a major S&P 500 reversal in May 2011, one that shaved nearly 300 points off the S&P.

It can be treacherous to buck a QE-stock market on a mission, but this major inflection point along with the bearish RSI divergence and increasingly bullish sentiment suggests definite caution ahead.

The Profit Radar Report reveals the key resistance level (and target for this rally) along with conservative and aggressive trade recommendations to take advantage if this strong inflection point.