Toppy Markets Confound Technical Analysts

One thing most technical analysts agree on is that the market is currently overbought. What they can't agree on, however, is whether this bodes ill for stocks.

The stock market has moved up sharply over the past two months, with both the Dow and S&P 500 climbing about 9% and the Nasdaq up 10% since hitting a low on Nov. 18.

"The market has reached a technical condition that has oftentimes preceded a market pullback, or at the least an extended consolidation phase," said Francois Trahan, chief investment strategist at Bear Stearns.

The indicators that Trahan monitors closely suggest that stocks are extremely overbought. In technical analysis, stocks are said to be overbought when more demand exists than is historically normal. The concept is part of the chart-based philosophy employed by these analysts to predict movements in individual issues and the broader market. (To see a free sampling of the latest technical opinion from columnists on our subscription sister site, RealMoney.com, click here.)

Technical analysis is viewed by some as a science that can discern supply-and-demand trends in stocks, and by others as snake oil that has no probative meaning. Because it has so many adherents, however, its findings can sometimes be self-fulfilling prophecy in the short term.

Trahan looks at the percentage of companies trading above their 10-week moving averages, because he believes this has been a reliable indicator in the past, heralding the consolidation in the summer of 2003. At present, almost 90% of stocks are above their 10-week moving averages, which he said is "well into overbought territory."

The VIX, or volatility index, a measure of fear in the market, is also flashing a warning signal while various sentiment surveys are pointing to a high level of complacency and bullishness among investors. The put-to-call ratio has not yet reached a critical level but is moving in that direction, Trahan said.