Market overbought but sentiment still favors bulls

Our first chart shows the S&P 500 Index with our three primary medium-term
indicators (oscillators) — one each for price, breadth, and volume. As you can
see they are approaching the overbought side of their range, but they are far
short of being at their extreme limits, and they still allow for higher prices
before they make a final top. Another thing to remember is that oscillators
oscillate within a fixed horizontal range, prices normally do not. This means
that, even though the oscillators top and begin to trend down, prices don’t
necessarily have to follow. In fact, you can see a few instances on the chart
where prices continued higher even after the oscillators topped.

Our next chart is of the Rydex Cash Flow Ratio (see below), which I featured in
an article two weeks ago. Note that the Ratio remains oversold (reflecting
strong bearish sentiment), in spite of the fact that prices have continued
higher. The condition of the Ratio is caused by a combination of aggressive
buying of bear funds and timid acquisition of bull funds. This situation is
extremely unusual, and I believe it must be relieved before we can expect a
significant price decline. Relief will come when the bears give up and the bulls
become more aggressive, ultimately causing the Ratio to move back up toward the
top its trading range.

Bottom Line: The significant aspect of the market being overbought is
that it is probably not a good time to be adding new long positions. Also, more
caution is appropriate while the overbought condition is being worked off.
Otherwise, I think the Rydex Cash Flow Ratio strongly suggests that prices will
move higher, even after internals begin to correct downward. In other words, I
think that people need to become more bullish before the rally will end.

Technical analysis is a windsock, not a crystal ball. Be prepared to adjust your
tactics if conditions change.