• As of last Thursday, 73% of the NASDAQ 100 (NDX) issues were overbought using a 14-period stochastic oscillator (Exhibit 1). Since the rally off the March low, readings greater than 70% kicked off consolidation periods in a clear uptrend.
• The average decline from above 70% reading to consolidation low was 4% over the following 14 trading sessions. It is important to note that as more time elapses since the March low, the consolidations seem to be longer and deeper, meaning this consolidation could be worse than the average (Table).
• In a healthy market trend (Exhibit 2), overbought isn't as much a sell signal as a "don't chase and wait" signal. In a well defined trend of higher highs and higher lows, being negative doesn't make much sense. What does make sense is to not chase and wait until extreme near-term overbought levels are worked off.
Table 1 - NDX takes a chill after 70% overbought reading
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