Overbought Stock Market Pullback...Finally....

By: Jack_Steiman

The market was begging for it. Day after day we stayed pretty much at overbought levels on all the major oscillators. The RSI's are sometimes staying well above normal overbought levels of 70. Readings in the lower 80's are not abnormal. You sit and wonder how long it can last. You know it's going to finally sell hard, but figuring out that moment is not an easy chore by any means. We have stayed overbought longer than most would have thought possible, and those who shorted at the first signs of overbought paid a big price as the market kept climbing higher. You had to stay with the trend as long as need be all the while waiting for the morning you wake up with the futures down hard. When these snap downs occur, it usually is with a strong gap lower that holds and trends lower throughout the day. Not necessarily always having to close on the lows, but clearly closing below the gap down readings. The bulls finally unable to make up the losses that took place early on. In the past that was an easy task, but finally today we saw the bulls unable to make it back.

That is a good thing for the bulls and this market. You get to the point where you're almost begging for the market to sell and stay down so as to be able to buy back stocks at a cheaper level with the oscillators finally unwound. Buying when those oscillators are high all the time makes it difficult to get overly involved. The selling here should provide entries at far better and safer levels soon enough. For now we watch and wait for some type of bottoming sticks along with enough unwinding of those oscillators. You can then add to your long side positions with far greater safety and confidence. I'm glad the selling has kicked in. It'll do the bulls good in the long run. I hope the selling intensifies somewhat further from here, but we shall see what the bears can offer up.

Selling was pretty much across the board, but two things were clear today. The higher beta and more frothy stocks took it on the chin pretty hard, while the recent best stock earners held up the best. This is key for traders to understand. The market will naturally gravitate to the stocks that have the least risk based upon what they reported just a week or so ago. They know these stocks are safest for a multitude of reasons. One, they know big money supported the moves up off those reports and will therefore be around to defend them when they get to support.

In addition, there's real safety in knowing these companies just reported and will, therefore, not have to report some unexpected bad news that can really hurt the price action. Traders are always searching for safety. Knowing a company just had good things to say takes the risk off to a high degree. Avoid the stocks that have struggled hoping they'll awaken when the market turns back up again. What was a laggard will likely stay one. Never a guarantee, but that's usually how it works, until those stocks can get some unexpected good news currently not available. Stick with strength. They will do the best on the next upturn.

Always keep in mind what got the market to this point when trying to understand what's going on with price. Whether this is selling that is real, versus selling to simply unwind overbought oscillators. If the market wanted to sell due to bad news, it would have a tough time as there has been mostly good news lately. Start with Mr. Bernanke, who once again last week promised to do what's necessary to keep the economy humming along. He will additionally keep interest rates near zero for the foreseeable future virtually guaranteeing the market will hang in there as there's nowhere else to put your dollars if you want growth.

We also just had an unexpected and a very happy surprise when the ISM Manufacturing number was reported, a nice move away from 50.0, which is the dividing line between growth and an economy in recession. Add in good earnings reports, overall, and this market should be doing nothing more than unwinding oscillators for now. The point here being that if we sell even further and harder in the days ahead, don't get too bearish too quickly. It probably won't serve you very well. With S&P 500 1480/1480 great support, I would not expect the market to lose 1470 any time soon. But we are always on watch. For now, the market is simply unwinding overbought.

Peace,

Jack

Jack Steiman is author of SwingTradeOnline.com ( www.swingtradeonline.com ). Former columnist for TheStreet.com, Jack is renowned for calling major shifts in the market, including the market bottom in mid-2002 and the market top in October 2007.

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