U.S. stock indices are showing signs of being “overbought.” This situation arises from how the market behaves during strong price trends. When prices trend upward, they can go beyond what traders expect, making it tough to predict when a correction might happen. Trends often go further than expected. For example, the S&P 500 has increased by 29% since April. Trying to guess when prices will peak can lead to missed opportunities or losses.

Using Technical Analysis Tools

To navigate this challenge, it’s wise to use technical analysis tools. These tools help spot market trends and shifts in control between buyers and sellers. Instead of trying to sell at perceived high points, wait for prices to drop below key technical levels. Technical analysis shows where buyers may lose short-term control, hinting at a potential advantage for sellers. If key levels hold strong, sellers won’t gain momentum even in an “overbought” market. Understanding these factors can help avoid jumping out of the market too early or facing losses from going against the trend. The S&P 500’s Relative Strength Index (RSI) has been above 70—indicating overbought conditions—for a long time. With the index up over 14% this year, it shows we are in a strong and upward trend. Instead of resisting this momentum, it’s sensible to assume the market might become even more overbought in the coming weeks. This ongoing strength is driven by excitement around artificial intelligence and expectations that the Federal Reserve will keep interest rates steady or cut them later this year. The CNN Fear & Greed Index is firmly in “Greed” territory, indicating that current sentiment supports higher prices. We should not go against this sentiment unless we see clear signs of a change.

Overbought Conditions and Historical Lessons

History shows that being “overbought” isn’t a reliable signal to sell during strong trends. For instance, during the dot-com bubble in the late 1990s, the Nasdaq stayed overbought for months, punishing anyone who tried to predict a top too soon. Remember, exiting the market too early can be just as harmful as a loss. For those trading derivatives, it’s better not to buy puts or create short positions based solely on valuation. Instead, consider strategies that benefit from continued price increases or sideways movement, like selling out-of-the-money put spreads below key technical support. We’re keeping an eye on the 50-day moving average, currently around 5,180, as an important level. Only if prices break and stay below this key technical level will we see sellers gaining ground. If that occurs, it would signal time to change strategies and start bearish positions, such as buying puts. Until then, we must acknowledge that buyers still have control, regardless of how overbought the market appears. Create your live VT Markets account and start trading now.

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