How To Play An Overbought Market

May 30, 2003
Dave Landry

On Friday, the Nasdaq opened firmer and rallied nicely in
early trading. It found its morning high by mid-morning and essentially chopped
sideways for the remainder of the day (with the exception of making marginal new
highs in afternoon trading). This action has it closing well and at
new highs for the year yet again.

The S&P put in a similar performance.

Looking to the weekly charts. Things are shaping up.

The S&P is breaking out to multi-week highs.

This action is more pronounced in the Nasdaq.

Looking to the monthly charts, I can see why people feel
compelled to make the case for this being only a bear market rally. However,
since my time frame is short to intermediate-term*, I have to go with what I am seeing on the daily
(and now weekly) charts.

The Nasdaq:

And, the S&P:

So what do we do? Longer-term readers of this column know
how I feel about overbought markets. To those new to this column, to put it
bluntly, they create a damned if you do an damned if you don’t situation. If you
throw in the towel and buy, the overbought condition corrects itself. If you try
to short it (or exit longs), overbought becomes more overbought.
I suppose the good news is that, if you are a truly are a trend player, you should be
already long some issues. Therefore, continue to take some profits and trail a stop
higher. Further, I would limit any new buying to commodity related or defensive
stocks that have the potential to trade contra to the indices. On the short
side, you might look to play the index shares on a reversal as a hedge for
existing longs–just don’t overstay your welcome since you are fighting the
trend.

Looking to potential setups, Progress Energy
(
PGN |
Quote |
Chart |
News |
PowerRating), in the
strong electric utilities (the green line below), looks like it has the potential
to resume its accelerating uptrend out of a pullback/Trend Knockout.