FOURTH QUARTER RALLY MAY BE READY FOR PAUSE AS MARKET LOOKS OVER-EXTENDED
DOW IS OVER-EXTENDED ... Yesterday I wrote about the Dow Industrials running into some selling along its early 2005 peak just below 11,000. I also mentioned it being over-extended. That can be plainly see in the 9-day RSI line which is well into overbought territory over 70. That's true of all the major stock indexes. Last week I explained that the RSI line should be used in conjunction with the ADX line to try to pinpoint short-term tops. I'm going to apply that indicator today to the the Dow. The ADX is the black line shown below the Dow chart. A rising ADX line implies an existing trend. When the green line is over the red line (as it is now), that trend is up. I also pointed out that the market can keep rising as long as the ADX line is rising as well. At least until it enters an overbought condition of its own. There are two criteria for determining that. One is any move over 40 which usually means the current trend is over-extended. The last time that happened was during May. The second criteria is when the ADX line crosses over the upper DI (Directional Index) line as it has done. The third thing needed is an actual downturn in the ADX line. That hasn't occurred yet. But the ingredients are there for a pullback or consolidation in the Dow. As I suggested yesterday, any pullback would be cushioned by support along the 10,700 level.
Chart 1
S&P 500 ALSO LOOKS OVER-EXTENDED ... Other short-term indicators paint over-extended pictures for the S&P 500 SPDRS (SPY) and the Nasdaq 100 Shares (QQQQ). Chart 2 shows three versions of Bollinger Bands. The line along the top (%B) plots the bands as an oscillator. A reading over .50 means the trend is up (over the 20-day average). A reading of 1.00 means the price is touching the upper band which is an overbought reading. The %B is now in overbought territory and starting to slip a bit. The line beneath the chart measures band width (the difference between the two bands). A trend is strong when the band width is rising which it's been since early November. A dip in the band width (which is now happening) often signals a short-term top. That could mean nothing more than a short-term consolidation or pullback within the ongoing uptrend. If the latter occurs, support is likely at the 20-day average or along the summer highs near 124.
Chart 2
Chart 3
NASDAQ 100 OVERBOUGHT ... Chart 3 shows the Nasdaq 100 Shared (QQQQ) is a similar overbought condition. The line on top is the 12-day Rate of Change (ROC) oscillator which is starting to weaken for the first time since July. That implies that short-term momentum is weakening. The lines along the bottom show the ADX line trading over the green line which is another sign of an over-extended market. If a pullback does occur, the first line of support is the 20-day moving average (green line). None of the short-term indicators shown in the three charts above signals an end to the fourth quarter rally. They simply suggest that the rally is probably in need of a breather.
