The market operates on human behavior.
This is clear by the irrational rally of NVIDIA (NVDA) now trading above $400 per share… while great companies with strong cash flow are falling Tuesday.
Irrationality is a hallmark of investing, trading, and human psychology.
I’m always focused on fundamentals in the market. From a microeconomic perspective, we use metrics to measure how companies boost their return on equity, increase profitability, enhance shareholder return, and lock down their balance sheet.
But technical analysis is also extremely important.
Even the strongest fundamentals can’t reflect a strong price trend in a stock. There are stocks that look cheap but might be value traps because of their volumes and the types of investors they tend to attract.
That’s especially the case in the nano-cap to small-cap environment. Different analysts have different price conclusions, and this is just one little piece of the puzzle for investors trying to navigate the landscape.
So, how do we read investor sentiment in real time?
When can we safely say that the selling is too extreme? Or argue that the rally is too long in the tooth?
To answer these questions, let’s turn to one of four critical technical tools that I watch as an investor and trader… the Relative Strength Index.
Buy Cheap, Sell Strong
The RSI, or relative strength index, is a great technical tool to gauge market sentiment on a specific stock.
Welles Wilder, Jr. created it in 1978 to measure recent price movements and the strength of a stock’s price trend.
The RSI ranges from 0 to 100, with extremes indicating buying and selling conditions. The industry standard is a 14-day measurement.
An RSI under 30 suggests oversold conditions, signaling a potential buying opportunity.
Conversely, an RSI above 70 indicates overbought conditions, hinting at a possible pullback.
Let’s examine a chart that illustrates this behavior.
You all know NVIDIA. The chipmaker has been on an absolute tear since hitting lows in October.
Back then, shares had an RSI of 30 on its daily chart. On its weekly chart, it also had an extremely oversold reading: 31.11.
When shares peeled back to the 31 level on the weekly chart, sentiment was extremely bearish – not just for NVDA but also for the market itself.
At the time, the United Kingdom faced serious economic problems, the U.S. mortgage-backed-security market was under stress, and there were increasing challenges facing emerging markets.
But you can see that investors willing to follow the policy pivots and buy the stock in oversold conditions would have made a pretty nice profit even before Artificial Intelligence sentiment overwhelmed the NASDAQ 100 and S&P 500.
Today, NVDA is clearly overbought and has become a traders stock. Its RSI on the daily, weekly, and monthly charts are now all above a 70 reading.
From a momentum perspective, it’s still possible to buy and trade a name like NVDA, but it requires very sound risk management and a commitment to learning other technical indicators to help you find success.
We’ll talk about another momentum indicator tomorrow that’s just as powerful as RSI – and will improve your timing in the future.
To your wealth,
Garrett Baldwin
*This is for informational and educational purposes only. There is an inherent risk in trading, so trade at your own risk.
Market Momentum is Red
There are questions about the likelihood of a debt deal and the upcoming OPEC+ meeting. Policy is dominating the narrative in the market, and we haven’t even started talking about the Fed’s upcoming meeting in two weeks. This negative news cycle is one reason why you need to consider a longer-term focus.
