S&P in a “Very Overbought” State leading into Monday’s Short-term Seasonal Bearishness

After moving sideways for most of the day the major indices moved higher during the last few minutes of trading. This brought the S&P (SPY) into a very overbought state leading into a seasonally bearish day. Monday, the fifth trading day of the month is quite bearish as only 19.0% of the days have finished higher. However, as I always state, seasonality alone is (in almost every case) not a reason to place a trade.  When compared  with the current state of the market at the time the seasonal tendency arrives, the probability of a successful trade can be increased tremendously.

Our shorter-term proprietary indicators have also reached an extreme which often signals that a short-term decline is right around the corner. Overbought markets are tough to gage. Unlike oversold levels they can stay in an overbought state, particularly in a momentum driven market, for quite some time. The Dow (DIA) is a very good example. DIA has been in an overbought state for weeks (since 4/13) without taking a breather. Overbought conditions can last for a month or so, whereas an oversold condition typically lasts at most a week.  This is why anticipating a top is such a difficult task.

Overbought/Oversold levels for May 4, 2007

• SPY -  80.3 (very overbought)
• DIA - 87.8 (very overbought)
• IWM - 65.3 (neutral)
• QQQQ - 74.1 (overbought)
• GLD -  66.4 (neutral)
• OIH - 75.1 (overbought)

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