Overbought Readings Would Be a Blessing For Stocks

I look at just one oscillator to supplement my price analysis - and that is the Relative Strength Index (or RSI). I say supplement because it's only price that pays us, so anything else is secondary. Now with that said, one of the most simple, yet extremely useful observations you can make in RSI is to see what kind of mode the underlying asset is currently in: Bearish or Bullish.

As I explained in this post, when the (14-period) RSI is in bullish mode the oscillator tends to move into overbought territory (above 70) during rallies, while never getting oversold (below 30) as it naturally corrects. The inverse is also true when assets are in bearish mode - the range gets down into oversold territory while never getting overbought during counter-trend rallies. So in other words, overbought readings are a good thing - it's evidence of buying. It tells us that there is an extreme amount of buyers present for that particular asset, whether it be a stock or Index.

Right now none of the major US equity averages have reached overbought levels on their daily charts. Since the price lows in August (where RSI showed extreme oversold readings), the market has yet to get above 70. In fact, most of the indexes still haven't seen anything above 65 in RSI, which is typical of an asset in bearish mode. Here are the Indexes one by one where you can see the oscillator (in black) behind the price action (in red):

Dow Jones Industrial Average:

S&P500

Nasdaq100

Russell2000

NYSE Composite

The bottom line is that US Stock Indexes are in "no-man's land", as far as the Relative Strength Index is concerned. Sure price action looks great as we make new highs. But to have some serious bullish conviction going forward, you really want to see some overbought readings in RSI. You definitely don't want to see any oversold readings, otherwise that would confirm the bearish mode that we've been in since late summer. But in this oscillator, at least, overbought readings would be a good thing and should be considered a blessing.

Tags: $SPX $SPY $DJIA $NDX $NYA $QQQ $RUT $IWM