The 'Overbought/Oversold' Myth
Two weeks ago, someone suggested that the stock market might be overextended, citing the 'overbought' state of the stochastic and other momentum indicators on the daily and weekly charts of the S&P, $COMPQ, $NDX, $DJIA, and $RUT. In response, let me start by saying that any given indicator, when considered in a vacuum, is practically worthless insofar its ability to predict the future. After all, an indicator is no more than a mathematical formula that acts upon the raw price data. Consider this for a moment: if an analyst fails to reliably forecast future prices by examining the raw data, why would he/she succeed by using a massaged version of the same data? It's utter stupidity!
To be fair, I do make extensive use of two momentum indicators, the stochastic and the MACD. When properly configured, these two indicators allow me to count cycles and momentum waves, as well as to spot extremes in both price and momentum (i.e., bullish/bearish divergence patterns). Indicators do provide valuable information, but they're only one piece of a much larger puzzle. I also use them as a trigger mechanism for entering a trade once a high-probability setup has been identified. A word of advice: if you're on a quest for that magic indicator that can embrace the vastly complex market and dumb it down so as to produce reliable BUY and SELL signals out of a black box, let me spare you the trouble: no such thing exists.
2012: A Fledgling Uptrend?
The question on everyone's mind is whether the rally that began on October 4th of last year is the real thing or an insidious plan aiming to hoodwink everyone into believing that the bull market is back in full force. At this time, I have no reason to doubt that it's real, and I continue to stand behind the forecast depicted on chart 1. However, chart 2 strongly suggests that a correction is overdue, even though a technical SELL signal is yet to be triggered.
(Place mouse cursor over the chart to enlarge)
Chart 1. The wave structure of the S&P on the weekly timeframe.
(Place mouse cursor over the chart to enlarge)
Chart 2. The S&P's wave structure on the 60-min timeframe.
Red wave [b] on chart 2 above has likely ended, but we won't know for sure until Monday morning. Friday's closing price in the S&P was 1315.38, only 11 pennies shy of Thursday's high of 1315.49. Moreover, the mild pullback on Friday morning appears to have unfolded as a falling wedge (chart 3), suggesting a corrective pattern in wave [b] that set the stage for further gains ahead.
Chart 3. A falling wedge on the 1-min chart of the S&P set the stage for a late-day bounce.
Back to chart 2, I'm looking for red wave [c], red wave [5], green wave (c), and green wave (3) to all come to a completion simultaneously. Based on the Fibonacci projections shown on the chart, 1325 appears to be the ideal target for all four waves. Should price reach this level and persist in its journey upwards, the next ideal target is somewhere near 1340 (not shown on the chart).
Further evidence can be obtained by examining the market profile chart. When I zoomed in on chart 4 below, I found out that the topmost 'A' of the selling tail (the red box containing three A's) ended at 1307.41. With price currently well above it, the next magnet is the value area inside the blue box. This particular distribution dates back to July 2011, and its Point of Control happens to be at 1316.31. Once inside this box, price will very likely gravitate towards the top at 1340. Unsurprisingly, this coincides with the 'next ideal' Fibonacci target discussed above.
Chart 4. The market profile chart.
This coming week will be action-filled. Aside from the much-awaited economic data points, $AAPL and other bellwether names will be reporting their earnings. The other much-anticipated event is the FOMC meeting announcement on Wednesday. Therefore, the murky waters will have to be navigated very carefully. Somehow, I feel that the squeeze will remain in full force until the skeptics finally throw in the towel and get back in. That's when the selling will begin, but only in profit-taking fashion. If and when it does, I expect a 50% retracement of the up leg that emanated from the lows of December 19th. The ensuing up leg should then target the May 2011 high (it will fall short on the first attempt).
Trade Well,
Peter