Things are Calming Down a Bit

I like looking at charts because it allows me to avoid making really dumb mistakes. One of the worst and most expensive mistakes is to jump on the band wagon of euphoria and buy too high. Historically it is the least profitable and the riskiest way to invest.

Last December, I warned that things are getting too good and the market is getting quite overbought. I pointed out that the RSI indicator (Relative Strength Index, middle panel on the chart below) was trading above 70, which historically was an overbought reading and was a bellwether to a pullback of some sort.
Three weeks later, the RSI indicator has gone back down within working range. What’s very encouraging is that the market did not have to go down substantially to ease this overbought pressure, instead it just had to trade sideways for a bit. That indicates that there are still buyers to support these prices.

Because of that, I do believe that buying now is less risky than it was three weeks ago because the market is not as overbought anymore, however, I would still proceed with caution. While momentum did go down from extreme levels, market participation (bullish percent index on the bottom panel) is still showing a reading that corresponds to a market that is still too excited.

As a refresher, the Bullish Percent Index fluctuates from 0% to 100% and measures how many stocks on the market (S&P500 in particular) are representing bullish action at the moment. A reading of 70% means that 70% of 500 stocks on S&P are bullish at the moment and so forth.

While it is healthy to see broadening participation during a market rally, readings of 70% or above historically have not been the best junctures to buy. The current reading is just below 70%. Therefore, I would encourage to still proceed with caution and if you must buy, do it in tranches.

If the market will go down, I would be very comfortable buying more aggressively anywhere between 4400 and 4600 points (between red horizontal lines). Nothing is guaranteed, but this level in my opinion will reduce your risk substantially. We do expect a good year, so this is just a way to get a bit more from the market.