Overbought, With Negative Divergences

Here we go again. We get overbought and we have a few days of rocking around, sideways action. We've watched this movie before.

The last few times we got overbought we milled around for a few days, maybe even had one decent up day, and then after we used up the majority of the overbought reading we fell off right at the end, just as we were almost back to oversold.

And, of course, that fall off just back to oversold sent the put/call ratio soaring and the bears came out of hibernation; right as we were getting oversold.

So what's different about this overbought reading? What's the same?

Well, what's the same is that thus far we're doing the sideways shuffle.

What's different is this is the first time the overbought has come with all these negative divergences I keep discussing. We didn't see that at the previous overbought readings. So that's what is bearishly different.

What is bullishly different is that at the previous overbought readings we saw the total put/call ratio fall to the 60s. This time we haven't even been able to push it into the 70s.

So perhaps folks have seen this movie many times before. As you know, I have this view that the market teaches us a lesson over and over again until we finally learn it. Then it changes the action. Therefore, folks are saying to themselves, "I am not falling for it again; I will not get bullish while we're overbought."

There was an interesting shift in the Investors Intelligence readings this week. The bears plunged again. This week's reading was 21.3%. We were last this low when the reading in late August was 19.8%. Keep in mind that during the four days after that reading in late August the S&P 500 fell from 1030 to 990. Not horrible, but surely an overbought smack.

Then there are the correction-minded folks. They chimed in at 32.6%, a very elevated reading. I can find two other readings that high in the past few years. Both are indicated on the chart with an arrow. The most recent was June 1, which led to the big June/July correction. The second was way back in early July 2007, which led to a correction in the market of about 10%.

So while we tend to want to "fade" the bulls and the bears when we see them at such extremes, I have found that we often would prefer to trade with these folks when they are so heavily correction-minded. This time we have too few bears and many looking for a correction.

And we're overbought.

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For more explanation of these indicators, check out The Chartist's primer.

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Know What You Own: Meisler mentioned the S&P 500. Some stocks in the index include Pfizer (PFE - commentary - Trade Now), AT&T (T - commentary - Trade Now), Target (TGT - commentary - Trade Now), Honeywell (HON - commentary - Trade Now), Dell (DELL - commentary - Trade Now), eBay (EBAY - commentary - Trade Now) and PepsiCo (PEP - commentary - Trade Now).

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At the time of publication, Meisler had no positions in the stocks mentioned, although holdings can change at any time.

Helene Meisler writes a daily technical analysis column and TheStreet.com Top Stocks. For more information, click here. Meisler trained at several Wall Street firms, including Goldman Sachs and SG Cowen, and has worked with the equity trading department at Cargill. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. She appreciates your feedback; click here to send her an email.