The Dow, 22000 and Overbought Readings

• Posted by Greg Harmon
• on February 17th, 2017

Following the election the Dow Jones Industrials Average (Dow) went on a tear to the upside. From the break out of a downward channel that had lasted over 4 months it rose 2,000 points in about a month. In mid December it it stopped though and sat around the 20,000 level. “Experts” suggested it would never hit 20,000 at first as it was overbought. Like a binge shopper it needed a rest after that move.

The Dow churned around 20,000 for about 2 months, proving the experts wrong in the process, but not really doing anything. then in February it started higher again. As we head into the President’s Day Weekend the Dow sits at record highs around 20,600 and is into the overbought zone again. What is next?

The chart above gives many clues. The first is a Measured Move to the upside. Quite often the move higher into a long consolidation, or bull flag, is followed by another move higher of equal length. This Measured Move would take the Dow to 22,000. That is great but what about that overbought thing?

Overbought is a relative term. When used to describe momentum it is usually defined as an RSI level over 70. And the current level of the Dow at 77 would qualify. But overbought does not mean that a move is done. Traders like to say overbought can always get more overbought.

Overbought also does not mean a reversal is imminent.You only have to look as far left on this chart as to the last time the RSI became overbought. The Dow was at about 18,800 when it became over bought and continued to move higher to just shy of 20,000 before it stopped, another 6%. And the Dow stayed overbought for 6 weeks before the RSI reset lower. And what about that reset? It was not a reversal at all but a correction through time.

The Dow and the rest of the stock market has been incredibly strong since the election. And the markets are indeed seeing conditions that can bring a correction. But there is no reason for anyone to bank on a correction to be to the downside until the price action shows that is the case. Understand the market you see not the one that could be.

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