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Weeky Review - sure we're over-bought but is that really a negative?

I've been doing a bunch of new development on the Alert HQ software, upgrading to a more robust database, automating more tasks and improving the Swing Signals algorithm. I also took some time off to enjoy the family over the Easter holiday. Bottom line - I'm late in posting the Weekly Review.

Being late, I won't go into too much depth but I do want to present the usual two charts.

TradeRadar Alert HQ Stock Market Statistics --

Each week our Alert HQ process scans almost 7300 stocks and ETFs and records their technical characteristics. The following charts are based on daily data and presents the state of some of our technical indicators.

This first chart presents the moving average analysis for the entire market and contrasts it with the performance of the S&P 500 SPDR (SPY). When the number of stocks trading above their 50-day moving average (the yellow line) crosses the line that tracks the number of stocks whose 20-day moving average is above their 50-day moving average (the magenta line) there is an expectation that you will get a change in the trend of the S&P 500.

Look at the yellow line - the number of stocks over their 50-day moving average is hitting the highest level since we started tracking back in early 2008. Almost 80% of all stocks we evaluated are now over their 50-DMA. To me this screams "over-bought" but sure enough this represents another increase in this measure compared to last week's results.

This next chart is based on Aroon Analysis and compares our trending statistics to the performance of SPY. We use Aroon to measure whether stocks are in strong up-trends or down-trends. The number of stocks in down-trends is indicated by the red line and the number of stocks in up-trends is indicated by the yellow line.

In this chart, it looks like the indicators are finally running out steam. The number of stocks in down-trends can't get much lower without going negative which, of course, is not possible. The number of stocks in up-trends finally stopped increasing this week and actually dipped slightly.

Conclusion --

I've been interpreting the statistics presented above as indications that the market is extremely over-bought and due for a pullback. After reading a post by Dr. Duru this weekend, I realize this can be looked at in a another way. The point of Dr. Duru's post is that at several major market bottoms, when stocks finally began to rally again, the number of stocks trading above various moving averages moved to very high levels, much as we are seeing in the charts above. This does make sense - after stocks were beaten down so low, any reversal, especially the beginning of a bull market, would indeed tend to result in a large number of stocks initially surging above their 20-DMA and, if the move is strong enough, above their 50-DMA also.

This kind of action would result in the charts we see above. Though stocks might truly be over-bought, the strength and the broad-based nature of this rally are very different than what we have seen over the last year. According to our data, way more stocks participated in this rally than in any of the previous rallies we have experienced during this bear market. This would lead one to think that when stocks finally do pull back, they will not be dropping to new lows but will recover and more than likely continue to new highs.

Lest anyone become too complacent, however, there is another opinion that contends that the fact that this rally is so broad-based indicates that buying has been indiscriminate. An article discussing this topic illustrates the point by describing several small caps that are nowhere near profitable or showing any kind of fundamental strength, current or future, yet have surged in price more than other, more deserving larger-cap stocks. This indication of froth, this line of thinking goes, shows that this is a bear market rally that has been grossly overdone.

So which is it? Over-bought and due for a pullback that sets the stage for further gains? Or Over-bought and due for a pullback that will see previous lows retested?

Trade Radar leans toward the former but worries about the latter. How about you?


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