A Short Sell-off Likely

Technical signals are indicating the market is overbought, usually negative for prices in the short run

By Paul Cherney

I have had four signals in the overnight systems run, they are all signalling overbought, usually negative for prices in the short-run (meaning the next few trade days). Two of the systems are based on breadth, one on price momentum and one on the VIX. Most of the studies I have done on the markets try to quantify extremes, movements outside the bell curve of probability. There can be outliers, numbers so far from the edges of the bell curve that they represent extremes which offer little or no predictive value.

This was the case as we plodded lower into the 9/21/01 bottom which is why I kept saying even though we were oversold, we would have to see prices demonstrate the ability to break above immediate resistance levels before recognizing that a short-covering rally was underway. (The markets were oversold, but couldn't bounce, now the markets are overbought, but might not decline.) Just as the fear which gripped the nation in the wake of the WTC tragedy set-off selling which pushed my indicators well outside the bell curve, so too, now, as the markets have bounced back from those extremely negative readings, the markets might not really sell-off even though I have traditional signals which usually precede at least a 2 to 5 day downturn in the market.

One potential reason the markets might not really sell off (except for just a day or two) is that many people believe that some sort of show of military force by the U.S. appears imminent in the War on Terrorism, and when that occurs, many people are expecting the "real" patriotic buy to occur in the equity markets. (On Jan 17, 1991, the first day of trading after the launch of Desert Storm, the S&P 500 gained about 3.7% on a closing basis, The DJIA gained 4.6%, The NASDAQ gained 2.9%.)

Granted, this is not the same kind of a situation, but you can understand the potential for real buying as a show of confidence that the tragedy of 9/11 will not go unanswered. I wish I could offer a more definitive opinion as to potential market direction, but that is the way I see it, markets can't always be broken down into numbers.

Technically overbought (recognizing, though that the markets were "oversold" for days without bouncing in the downleg into the 9/21 bottom), It makes sense to me that many are unwilling to abandon long positions in anticipation of a military move.

I still expect to see the DJIA close above 9400 before this upleg is over.

Cherney is market analyst for Standard & Poor's

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