Stock Market Collapse Trigger Pattern Repeating
Stock-Markets / Financial Crash Aug 10, 2009 - 02:37 AM GMTBy: Graham_Summers
Stocks are overbought.
And by overbought, I mean WAY overbought.
The relative strength index (RSI) is a metric used to measure the velocity and momentum of a given investment by comparing its upward and downward moves from close-to-close. If an investment is moving up strongly, its RSI is higher. Similarly, if an RSI is low, it means the investment is performing weakly.
Historically, RSI’s of 70 or higher mean an investment is overbought while an RSI of 30 means an investment is oversold. In these situations the market is primed for a “revert to the mean” trade, meaning you could see a quick correction or turnaround rally as the market snaps back to a more reasonably RSI.
Well, have a look at the NASDAQ today.
As you can see, the NASDAQ recently hit an RSI of 75. This is the highest reading we’ve seen in nearly two years. In fact, the last time the NASDAQ had an RSI of 75 was October 10, 2007, right before stocks entered their first major leg down in the Financial Crisis, losing 55% in six months.
As soon as I noticed this, I called up Ron Coby, a brilliant portfolio manager based in Medford, Oregon. Ron’s one of the smartest guys I know and when it comes to trading short-term moves, he’s one of the best in the business. What he had to say completely blew me away.
Ron said,“Graham, you won’t believe this, but I went back on the NASDAQ and made a note of every time it hit an RSI of 75. EVERY TIME, the market collapsed soon after. And I don’t mean a “plain vanilla” correction, I mean a full blown CRASH.”
Ron then forwarded me the following chart. Suffice to say, I was floored.
As you can see, the NASDAQ has hit an RSI of 75 or higher five times in the last 12 years. Every time, the market collapsed soon after with an average drop of -22%. In several cases, stocks suffered a full-blown CRASH.
This is a very serious warning for the Bulls. A high RSI doesn’t mean that stocks have to CRASH immediately. But it does indicate that the NASDAQ is more than ready for a serious correction. Again, an RSI of 75 or higher has only been hit FIVE times in the last 12 years. Two of those times were at massive historic bubble peaks. The others were all periods in which stocks were simply far too overbought. And ALL FIVE OF THEM PRECEDED SERIOUS CORRECTIONS.
Be forewarned, if stocks are this overbought, we’re in dangerous territory. If smart money like Ron Coby is worried and shifting to a defensive stance, I’m paying attention.
I suggest you do the same.
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Good Investing!
Graham Summers
Graham Summers: Graham is Senior Market Strategist at OmniSans Research. He is co-editor of Gain, Pains, and Capital, OmniSans Research’s FREE daily e-letter covering the equity, commodity, currency, and real estate markets.
Graham also writes Private Wealth Advisory, a monthly investment advisory focusing on the most lucrative investment opportunities the financial markets have to offer. Graham understands the big picture from both a macro-economic and capital in/outflow perspective. He translates his understanding into finding trends and undervalued investment opportunities months before the markets catch on: the Private Wealth Advisory portfolio has outperformed the S&P 500 three of the last five years, including a 7% return in 2008 vs. a 37% loss for the S&P 500.
Previously, Graham worked as a Senior Financial Analyst covering global markets for several investment firms in the Mid-Atlantic region. He’s lived and performed research in Europe, Asia, the Middle East, and the United States.
© 2009 Copyright Graham Summers - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.
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