Early Warning Wednesday: It's Complicated

Since it's Wednesday, it's time to review our Early Warning indicator boards.

The Process 

Once we have identified the state of the big-picture environment, the current trend, and the degree of momentum behind the move, we then look at the potential for a countertrend move to develop. This batch of indicators is designed to suggest when the "table is set" for the trend to "go the other way."

* Source: Ned Davis Research (NDR) as of the date of publication. Historical returns are hypothetical average annual performances calculated by NDR. 

My Take

The Early Warning board continues to be a mixed bag, as neither team appears to hold an edge at the present time. This probably sounds a little odd given that a great many analysts consider the current market to be very overbought. However, the current situation is complicated.

From my seat, it is important to recognize that we are dealing with a bifurcated market in which the major indices (save the NASDAQ) have been stuck in a trading range, while the NASDAQ Composite and NASDAQ 100 indices have been on an impressive roll and are indeed overbought - and due for a rest.

So, while the table may be set for a pause in the NDX, the bulls would appear to have some room to run in the S&P 500, and especially in the indices that require an economic recovery to work such as the DJIA, Russell 2000, Midcaps, etc.

Stochastic Review

Over the years, I have found that reviewing the basic stochastics is perhaps the simplest way to determine when an index or security may be ripe to "go the other way" for a while. I like to keep it simple here by using a 14-day %K (with one-day smoothing) and a three-day %D. It's not fancy, but it tends to be an effective tool that I rely on.

S&P 500 - Daily

View Larger Chart

In the chart above, it is clear that the stochastics remain in overbought territory. However, it appears that a "good overbought" condition is developing. As opposed to a traditional overbought condition, which tends to lead to countertrend moves, a "good overbought" condition is where a market "gets overbought and stays overbought."

The bottom line is I see this as a "rally continuation" sign, which tends to have bullish tendencies. So, unless the bears can get something going quickly, my take is that we now have a "good overbought" condition on our hands.