Overbought Conditions Reflect Strength and Said Strength Drives Momentum Rotation Strategies
Momentum and trend strategies are off to a roaring start here in 2024. More often than not, these strategies buy leading stocks that appear overbought. Buying stocks that appear overbought often goes against our "gut feel", but overbought conditions reflect strong buying pressure and this is clearly more bullish than bearish. Let's look at recent examples using the broader market and UBER.
Stocks surged in early November with an S&P 1500 Zweig Breadth Thrust signal and seemed to be overbought by the end of November. The S&P 500 and Nasdaq 100 were up 8.9 and 11.4 percent, respectively. TrendInvestorPro's Composite Breadth Model then turned bullish in early December and stocks again appeared overbought in late December. The S&P 500 was up 4.4% and the Nasdaq 100 was up 5.5% in December. Note that the Composite Breadth Model is 14 indicator breadth model used for broad market timing a TrendInvestorPro.
Despite big moves in November and December, stocks did not stop rising at the end of 2023. Instead, the advance continued in January-February with the Nasdaq 100 leading. This advance then broadened out in March with the S&P 500 taking the lead. The Nasdaq 100 rose 1.2% in March and the S&P 500 surged 3.1% this month. Again, the market appears to be overbought and ripe for a correction period. While I cannot argue with this assessment, I cannot predict a pullback, especially in a strong uptrend. There will be a correction at some point, but I do not know when. Perhaps we should stop using the term "overbought" when the trend is up and accept overbought conditions at face value. Overbought is really just another way of saying "strong".
Dual Momentum Rotation strategies are designed to take advantage of leading stocks with strong price moves. The methodology buys the top performing stocks and sells when they drop below a certain rank. The chart below shows a trade example using Uber Technologies (UBER). UBER entered the model portfolio as a top ranked stock on February 5th, and RSI was above 70 (green vertical line). RSI is considered overbought when above 70. In truth, a move above 70 reflects strong upside momentum and this is more bullish than bearish. Price moved higher and UBER's rank then dropped by the end of March (red line). UBER no longer made the cut and this triggered an exit signal.
Focusing on the strongest stocks within the Nasdaq 100 and S&P 500, the Dual Momentum Rotation Strategies at TrendInvestorPro are up double digits so far this year. Be careful chasing performance because it is not all roses when trading the leaders and there will be drawdowns along the way. These strategies were down in 2022, they recovered nicely in 2023 and there were also drawdowns in 2023 (September). These strategies are fully systematic and trade on a weekly basis. Rankings and signals are posted every Saturday morning for subscribers. Click here to see performance metrics and learn more.
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