Trader’s Narrative

Here’s yet another metric showing that the market may be approaching overbought conditions:

For those unfamiliar with this indicator, it is the percentage of stocks within the S&P 500 Index (SPX) which are trading above their simple 50 day moving average. So for example, if we had 100 trading above and 400 trading below, that would give us 20%.

This is a very good measure of the market internals and it has been a useful yardstick to measure oversold and overbought conditions. It was one of the indicators which got me bullish in January. Admittedly, that was way too early.

The concept can be equally applied to any moving average. Obviously the shorter the moving average, the shorter the time horizon of the metric. With the exception of the 10 day moving average which has proven to have incredibly prophetic characteristics even into the long term. In mid March the percentage of stocks trading above their 10 day moving average declined to an unbelievable 3%!

Getting back to current market conditions, we are now slowly approaching the other extreme: overbought. We aren’t there yet. Usually the market tops out when this percentage gets between 80% and 90%. When the market topped out in October 2007, this indicator reached 85%. But right now we are only at 74%.

So its just something to watch out for. Especially when compounded by other sentiment and technical indicators which similarly argue for a pause or retreat.