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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