Purely Technical Nightly Commentary (Oct 26, 2006):
Good Evening,
A number of "technicians" out there have recently been mentioning the fact that the stock markets are currently overbought. A number of these "technicians" have also been claiming that these "overbought" conditions mean that a market top is in sight and that shorting the market might be in order.
Do not blindly follow this bad advice. Now, don't get us wrong. We are not saying that there is no chance that a top may be forming. We're just saying that overbought conditions do not necessarily mean that a market top is imminent.
Let's take a look at this chart of the S&P 500 seen between early- and late-1995.
Over this period the S&P was overbought and then returned to the centerline, then got overbought agan and then got further overbought and then returned to the centerline and then got overbought again, until price finally consolidated - notice that we didn't say declined.
MACD just kept rising and rising until finally cooling off.
Now, did the market decline after this entire phase. No, it did not. It started to rally once again. That is what happens in a strongly trending environment.
The bottom line here, is that overbought conditions on their own do not signal a top. Momentum indicators such as RSI and MACD - when used properly - are useful in picking tops when there are negative divergences on the charts.
Speaking of the charts - as opposed to solely someone's opinion - let's look to see if the COMP is warning us of any potential for a top in the near future. (There are no negative divergences here as yet, by the way)
Truthfully, from a technical perspective, there is nothing to call a potential top in this market - until and unless the intermediate up trendline is broken.
Until that happens, any calls for a top are premature and based on hopes rather than on any technical truths.
The technical truth is that the index is up against solid resistance in the area around 2380. Does resistance= sell signal? No, it does not!
In fact, if resistance is broken, there is more of a reason to get bullish. This is because higher highs and higher lows are the sign of a bull market, not a bearish one.
So, the lines are drawn... Resistance is at 2380, support is in the form of the up trendline. Let's see which one gives first.
This is the market's message... Trade what you see, not what you want to see...