Overbought in an Uptrend

Most swing traders understand that the market has a tendency to oscillate. In other words, strongly oversold conditions will often lead to a bounce and strongly overbought conditions will often lead to a pullback. The trick in trading a swing time frame is understanding when the likelihood to reverse is strong and when it isn’t.

Trying to sell short when an uptrend gets overbought can be a dangerous endeavor. Often there will be no downside edge when trying to short into an overbought condition in an uptrend. When the market is strongly overbought due to a sharp acceleration in the trend as occurred late last week, it may even suggest an upside edge. Below is a study from last night’s subscriber letter that demonstrates this.

We see here a mild upside edge.

Actually the upside stretch is even more extreme that I show in this study. There were some momentum studies in last night’s letter suggesting an even greater bullish edge. There are also a few active studies that suggest a mild pullback could be in order. In any case, the point is that though the market is short-term overbought, this is by no means an ideal short setup. And in general odds seem to favor a continuation rather than a strong, immediate drop.