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Overbought

March 23, 2012 – 5:35 pm

The market is still in an upward trend despite a small fall this week. However, this current weakness could easily result in our first real pullback for the year. A pullback is a fall in prices for the indices of at least 3% at the very minimum but is more normal at 10%. Anything less than 20% is still considered a pullback and above 20% is a new bear market. Last summer the indexes reached 20% before rebounding. It actually did that twice last year, once in August and again at the beginning of October.

The reason why pullbacks are important is mostly psychological. Investors in a bull market bid up prices quickly, often developing in to a situation we call ‘overbought’ where prices run ahead of their value. This often begins to frighten investors and allows traders to take profits. That results in the correction and sets up the next leg of the bull rally. The longer a rally continues without a pullback the larger the correction will be. At least this is the normal reaction.

We have had a run in prices since mid-December. Three months of a continuous rally has put us in an overbought situation. It has not been a steep run up so the overbought condition is not frightening from a technical point of view and since the market did not increase at all last year the market is also not over priced. However, a normal correction would be welcome by most technical investors and would be health restoring.

Good Trading
Steve Peasley

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