OVERBOUGHT SIGNAL
Since the market has bottomed in October of 2022, overbought signal has been met with oscillator resetting to the bottom of the band (see chart below).
This is the first time since the March of this year that the oscillator has not retested the bottom of its band. So, technically, we can say that this rally has been on-going for the last four months.
So the question is, how long can they continue go-on like this without retesting the bottom of it’s band on the oscillator? Simple answer is, no one knows. We could potentially go-on like this for the remainder of this year.
However, we are stretching it and you can feel the complacency in the market; meaning, there is no fear in the market. And market typically do not like that. Market likes to create drama, and soon or later, I believe it is coming.
Since no one knows when the correction is coming, how should we prepare for it?
Well, we want to give benefit of the doubt to the buyers (since the trend is UP) while understanding that there is complacency and the market is waiting to punish the late-coming bulls. Remember, the oscillator has not retested the bottom of the band in four months on S&P 500.
So instead of trying to figure out exactly when the correction is going to occur (because the market will drive you crazy if you attempt to do this), I think it is more prudent to adjust your portfolio accordingly which I will talk more about it later on this post.
NASDAQ-100 also looks very similar to S&P 500 as the oscillator has not retested the bottom of its band since March.
THE DIVERGENCE SINGAL
As the NASDAQ moves higher and higher, the oscillator continues to make lower highs (see arrows chart below).
This typically happens when the market is stretched and preparing for a pullback after a prolonged bullish rally. Last time QQQ witnessed this divergence (during Dec-Jan), it did correct 12%. Again, we have to understand that market does NOT have to respect this signal as it can keep grinding higher for weeks before this signal actually plays out.
So how should you prepare for this?
Well, this is the time where you could really lighten up or even close out most of your aggressive longs such as call options or 3X Leveraged ETF. It’s always a good idea to keep some because you never know how long the market keep going higher. But, when it comes to your long-term holdings, this is not a signal to be worried about as your long-term holding should able to go THROUGH any sort of correction that might be coming.
With this divergence signal and extended/stretched price and the complacency sentiment, I do think about 10-15% correction is coming on the NASDAQ (possibly similar or less on S&P 500).
It’s extremely difficult to know exactly when, so you should not trying to time it perfectly. Rather, you should adjust your portfolio accordingly to able to go THROUGH it.
