SPX: Overbought, But Not Bearish

10/17/06 08:40:37 AM

by Arthur Hill

Even though the stochastic oscillator moved into overbought territory in September, the bulls keep charging and the S&P 500 has yet to lose upside momentum.

Security: $SPX
Position: Hold

This weekly price chart (Figure 1) shows that the Standard & Poor's 500 has been working its way higher for more than two years (since August 2004). The advance is a zigzag affair and a rising price channel formed. The lower trendline was drawn first and the upper trendline is parallel. This upper trendline extends to around 1380–1400 over the next few weeks and months. This is the upside target and implies another 10–30 points in the current advance. Prices would not be considered overextended unless SPX moves above the upper channel trendline.

FIGURE 1: S&P 500, WEEKLY. The SPX has been working its way higher for more than two years, since August 2004.

Graphic provided by: StockCharts.com.

The stochastic oscillator is way overbought and confirms that there is little room to turn. The indicator is at its highest level since January 2004. This overbought situation is not necessarily bearish. It just means the bulk of the advance is probably behind us. SPX is up over 11% since mid-July and the advance has been pretty much straight up. The advance is either likely to slow or we could see a correction in the next few weeks. A pullback followed the surge above 95 in December 2004 and a slower advance followed the surge above 95 in December 2005.

The second decline below 80 is the time to expect a correction. Looking at prior corrections, we can see that the stochastic oscillator dipped below 80, rebounded, and then a correction unfolded (blue boxes). The blue arrows show the dip below 80. As the indicator now stands, it is comfortably above 80 and shows no signs of weakness. A slower advance is likely as long as the indicator holds above 80. A dip below 80 would likely mean that a top was forming and the second dip would signal a correction.

Arthur Hill

Arthur Hill is currently editor of TDTrader.com, a website specializing in trading strategies, sector/industry specific breadth stats and overall technical analysis. He passed the Society of Technical Analysts (STA London) diploma exam with distinction is a Certified Financial Technician (CFTe). Prior to TD Trader, he was the Chief Technical Analyst for Stockcharts.com and the main contributor to the ChartSchool.

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SPX: Overbought, But Not Bearish

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