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“Dow is Overbought” Is More Bullish Than Bearish

The Dow Jones Industrial Average has been in overbought territory since the first trading day of this month and for a total of 10 days, according to a popular technical analysis indicator. But usually overbought conditions occur along uptrends.

Below is a chart shown the current overbought state of DJIA:

Note that in December of last year DJIA was overbought according to RSI(14) > 70 for 25 trading days but then rose to higher levels without any noticeable correction.

As I have demonstrated in another article, overbought conditions in the sense of an RSI(14) > 70 in equity indexes usually denote strength and higher prices in the future. They mostly occur along uptrends, as also shown in the S&P 500 chart below:

It may be seen that overbought conditions occurred only once along the 2000-2003 bear market in May 2001 and never along the 2008 bear markets. They are rare in downtrends because they are essentially free money signals for traders.

Some tehcnical analysts think that these overbought states mean that a market top or large correction will occur. However, there is no significant correlation between overbought conditions and corrections. Markets can work off overbought conditions in consolidation mode without having a correction.

Markets can stay overbought for longer than bears that rely on visual analysis
of chart can remain solvent.

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Charting and backtesting program: Amibroker


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