Climactic Activity Encourages Caution

(This is an excerpt from the June 22, 2012 blog for Decision Point subscribers.)

Decision Point has a number of ultra-short-term (days) indicators that help us monitor market conditions within that time frame. Primarily we are interested in overbought or oversold conditions, which identify buying and selling climaxes -- events that indicate that investor enthusiasm in a particular direction has become at least temporarily exhausted.

The bottom three panels on the chart below display three of our ultra-short-term indicators. I don't want to trudge out into the weeds and discuss these indicators in detail. Rather I urge you to study the chart and observe how the extreme reading quite often pinpoint significant tops and bottoms.

This week these indicators reached very high levels, which we thought could at the very least lead to a short period of consolidation. We didn't predict the sharp decline on Thursday, but it was within the range of possibility considering the internal conditions.

When pondering what the ultra-short-term indicators may be telling us, it is useful to give them some context by checking short-term (days to weeks) indicators, which do not oscillate so much. As you can see, the short-term indicators below had also reached very overbought levels, lending more weight to what the ultra-short-term indicators were telling us.

Finally, we look at intermediate-term (weeks to months) indicators. They are still rising from very oversold conditions, and they have plenty of room to accommodate higher prices. So Thursday's decline does not necessarily signal a major top.

Conclusion: Climactic readings do not tell us what is going to happen next, but they do identify extreme overbought/oversold conditions and flash a warning signal that the current price trend may have run out of steam, at least temporarily.

For more information on the indicators displayed here, see our Glossary section on the website.