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Does an overbought condition suggest a selling situation?


The stock market, as represented by the S&P 500 Index (SPX), continues to trend higher, posting new 52-week highs. The S&P 500 Index gained 695.37 points or 18.11% year-to-date.


It is an impressive rally placing the market at overbought levels as measured by overbought and oversold indicators, including the RSI Indicator (RSI = 67.94), the percentage above the 50-day ma (DMA50 = 4.98%), and percentage above the 200-day ma (DMA200 = 12.02%).


Does an overbought condition suggest a selling situation?


Not necessarily. Since the market (SPX) has recently broken out above pivotal resistances (4,195.44 and 4,325.28), this suggests a retest of crucial resistance coinciding with its all-time of 4,818.62 (1/4/22). Also, despite the explosive rally this year, SPX still lacks the technical sell signal to suggest the start of a bear market decline.


However, with the second quarter earnings underway, any substantial misses, specifically to the mega-cap technology names, can result in sharp market pullbacks at any given time (i.e., TSLA and NFLX earnings yesterday).


Yesterday’s rally to 4,578.43 may have encountered formidable medium-term resistance near the top of the Mar 2023 uptrend channel (4,591). See the 7/17/23 blog entitled “How High is High” for further information on converging resistance. Failure to break out of resistance and an overbought condition signals a potential market pullback. The consolidation is constructive as this would alleviate the overbought condition and allow for better entry points.


What levels can we expect to see on SPX pullbacks?


There were two large gap-ups at 4,443.64-4,463.23 (7/12/23) and 4,398.39-4,422.44 (6/30/23), respectively, and a higher low (4,385 – 7/6/23). Although these are minor supports, the closing of these two gaps and a lower low still places SPX comfortably above formidable secondary support near 6/13/23 gap-up (4,340.13-4,349.31), the bottom of the Mar 2023 uptrend channel (4,334), 6/26/23 low (4,328.08), 6/12/23 breakout (4,325), and the 50-day ma (4,319.5).


A decline below 4,319.5 (50-day ma) would breach the 4-month uptrend channel and warns of a deeper correction toward 4,195-4,241 (6/13/23 gap-up and the 5/26/23 breakout) and below this critical intermediate-term support at 4,048.5-4,049 (Apr/May 2023 lows, 5/5 and 5/25/23 island reversals, and the 200-day ma).

Violation of the 200-day ma (4,048.5) is bearish as this warns of the next SPX selloff toward Mar 2023 low (3,808.86) and Dec 2022 low (3,7864.49).


On the upside, the initial resistance is 4,578.43-4,591 (7/19/23 high and top of the Mar 2023 uptrend channel). A convincing surge above 4,591 confirms an accelerated channel breakout and suggests +257 points or an SPX target at 4,818.62-4,848 (1/4/22 all-time high and the accelerated channel breakout projection).


Source: Chart courtesy of StockCharts.com

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