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What An “Overbought” Market Looks Like February 20, 2015

Posted by Tom in Thoughts.
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The U.S. market, especially the NASDAQ Composite (my favorite benchmark) has been on a tear lately.  A quick look at the chart below shows the money flowing in (red histogram at the top) and the steep incline of prices over the past 3 weeks.  I’ve spotted in a rather aggressive trend line (reverse trend line in red) to show just how dramatic this advance has been.  (click on chart to enlarge it)

NASDAQ

With volume being rather modest (i.e. at or below average) we see that there are more buyers and fewer sellers, hence prices increase.  The rate of increase is something like 175% annualized (from 1-30-15 to 2-20-15).  Now, no one in their right mind expects the NASDAQ to end the year up 175% so something must happen to at least slow this assent.

Another indicator of stock accumulation (buying) is reflected in the pie chart below.  This shows the number of stocks that are in the S&P 1500 index (what some institutions refer to as “investable stocks”) that are in stages of Accumulation, Distribution or are Neutral.  There is a lot of green on the chart . . . too much.

Aum-Dist

So what is the next move and more importantly when?  No one knows but all (should) know that the time will come.  This is what an “overbought” market looks like.  At the least, the market could trade down to the lower red trend line and consolidate for a week or so, but a more significant correction even back to near 4810 is not out of the question.  News would be the likely catalyst for such an event.  Greece, Iran, Russia or what have you could make a splash and drive markets lower world-wide.

What is interesting is the amount of money flowing into the US markets.  With Europe and Asian Developing Markets rather shaky right now we are seeing money coming into what appears to be safety.   But is a market increasing at the rate of 175%/year safe?  The question really boils down to when a pause or correction will happen and not if.  I’ll keep my eye on the lower trend line and see what happens to volume and price action.  Wide spread bars down on heavy volume would concern me (selling coming in).  Also big up bars on very light volume  (lack of demand), or very heavy volume (buying climax) would be a major caution signal.  However, as with any market, it can stay overbought (or oversold) for quite a long time.  We have no idea “what inning” we are in.  But I’m thinking it may be wise to plan a hedge for positions and at least a mental sell stop in case we need them.  There is no use in giving up gains at this point.

Let me know via a posted remark if there are any areas you’d like me to cover in future postings.

Have a good week.           …………  Tom  ………..

chart by MetaStock; pie chart by http://www.HighGrowStock.com; used with permission

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