Before you dive headfirst into buying stocks left and right as the market surges higher Tuesday, I want to draw your attention to two important metrics for the weeks ahead.
Beware Overbought Conditions
There are two metrics that we use to measure overbought conditions in the financial markets. And right now, tech stocks are already in this position. Following a correction on the S&P 500 that ended three weeks ago, investors have moved fast and furiously into FAANG stocks that comprise the largest weight of the S&P 500 (tracked by the SPY ETF) and the Nasdaq 100 (QQQ). So, what are these metrics?
Take a look at the Relative Strength Index (RSI) daily reading of the Technology Select Sector SPDR Fund (NYSEArca: XLK). The RSI is a momentum oscillator that measures the speed and change of price movements. It ranges from 0 to 100, indicating overbought conditions above 70 and oversold below 30.
Now, let’s turn our attention to the second reading.
The Money Flow Index (MFI) is a momentum oscillator that measures the inflow and outflow of money in a security. It ranges from 0 to 100, identifying overbought conditions above 80 and oversold below 20. MFI incorporates both price and volume, providing insights into buying and selling pressure.
Now, as you can see, the XLK is clearly in overbought territory at the moment on our daily readings. And the time to have gone long happened back on Nov. 2, when the RSI, MFI and other two indicators turned positive at the same time (MACD and ADX).
Since we’re back in overbought territory, traders who are going long now need to set hard, tight stops to protect against any downturn.
With tech stocks leading the way, the QQQ is also back in overbought territory while the S&P 500 is now sitting just shy. The RSI on the S&P 500 is now over 70, but the MFI sits under 80, signaling that opportunity could remain for this rally to continue.
Looking Out Ahead
Today’s Consumer Price Index (CPI) came in lower than expected, setting off a massive rally for the S&P 500, Nasdaq 100 and Dow (DIA). But this snapback rally started three weeks ago when the RSI and MFI for the S&P 500 were in oversold territory.
As you can see, the RSI and MFI both pushed into oversold territory at the end of October. Since then, dip buying and optimism around interest rate cuts have accelerated, on top of short-covering among hedge funds.
These rallies from oversold to overbought and back again has been the norm of the last few months. With global liquidity improving thanks to stimulus packages out of Japan and China, this market continues to press higher despite an incredible amount of net-short targeting.
Keep a very close eye on these indicators — and other critical ones that we watch like insider buying and momentum. I recommend that you use a simple tracking site like FinViz.com or StockCharts.com to keep an eye on the S&P 500 and Russell 2000. With algorithms dominating trading, they continue to buy back into the markets in oversold territory and take profits when we get overheated.
Chat soon,
Garrett Baldwin
*This is for informational and educational purposes only. There is an inherent risk in trading, so trade at your own risk.
Very Few Traders Use This Buy Signal
Whether you’re a day or a swing trader, or a long-term investor…
There’s one stock market pattern that needs to be on your radar as we close out 2023…
It’s the No. 1 pattern traded by a former Wall Street Vice President…
And I found it to be incredibly useful in times of uncertainty…
It’s the same pattern that tipped him off to the dotcom crash and the Great Financial Crisis…
Now, I’m not saying a major market crash is coming…
But what I am saying is…
This pattern can be used to help keep you out of trouble if markets remain rocky…
But not just that…
It can be used to identify the market’s strongest moving stocks both to the upside and the downside.
