Amazon stock (AMZN) - Get Report has awakened from its late 2020 and early 2021 nap. From mid-May to mid-July, share price increased 18%, easily beating the S&P 500’s 6% climb during the same period. But while some may have welcomed positive momentum at last, others saw reasons to worry.
MarketWatch has recently reported on a technical indicator showing that Amazon, among other stocks (and even the stock market at large), might be overbought. The Amazon Maven looks at the possibility that a correction could be imminent.
(Read more from the Amazon Maven: Why Cathie Wood Has Gone Sour On Amazon Stock)
The cautious view
The key technical metric used to justify caution in this case is the RSI – the relative strength index that measures the magnitude of recent price changes in a stock. Mott Capital Management points out that Amazon’s RSI, while not the highest among Big Tech names, stretched to nearly 78 on July 8, and settled lower at a still rich 70 on Wednesday. See chart below.
What has caught my attention is that, in the case of the Nasdaq, a high RSI has historically coincided with a short-term correction. The tech-rich index saw its metric approach or even surpass 80 a few times in the past couple of years, and here is what happened in some of the most recent cases:
- September 2020: 15% decline in a matter of a few days;
- January 2020: 27% dip through the bottom of the COVID-19 crisis in March 2020;
- April 2019: 12% correction by late May 2019.
In other words: every time that the Nasdaq corrected more than 10% between 2019 and 2020, its RSI flirted with a reading of 80 a few days ahead – as did AMZN’s within the last week or two.
Fears of a stock being overbought makes sense to me. When a stock rises substantially and too fast, there is the risk that improved sentiment may have been overdone, and that a pullback in share price to more reasonable levels is reasonable and imminent.
That said, notice how these correction-and-rebound cycles have historically happened very quickly. The Nasdaq dipped in early September 2020 but made all-time highs again only three months later. In April 2019, the return to the peak happened in a matter of only 10 weeks.
Also worth noting, a high RSI has not always led to a correction. In early 2017, the metric reached peaks not seen since then not once, but twice. Yet, the Nasdaq never pulled back more than 5% during that entire year. Also, investors that sold stocks at a high RSI risked missing the ideal re-entry point, passing up on future gains.
Therefore, the Amazon Maven would warn longer-term investors against trying to time exits and entries. Sure, a correction in Amazon stock could materialize in the near term. But for the sake of growing capital patiently over time, investors are probably better off enduring the short-term bumps and focusing on long-term performance.
(Read more from the Amazon Maven: This Is A Top Reason To Sell Amazon Stock)
Amazon stock has rallied in the past couple of months, and some fear that the party might be over. What do you think happens to share price in the next few weeks?
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(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting The Amazon Maven)