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Right on schedule, the market backed off when it reached a maximum overbought reading. As a result, there will probably be many voices encouraging investors to buy the dips.
More than likely, equity holders will pile back into stocks following this latest overbought reading. That's typical. That's how the oscillator makes a lower high, which it hasn't done yet. First, though, the oscillator needs to become overbought.
In the meantime, the sentiment indicators I follow show that some investors are too bullish and others aren't bullish enough. The CBOE Market Volatility Index, or VIX, is low, and everyone seems to have an opinion on it. The bulls argue it can go lower, while the bears say with the VIX this far down, the market must decline.
The American Association of Individual Investors survey, a sentiment indicator I only care about when it's at an extreme, is on my watch list now. This reading moved to an extreme bullish level last week and now shows 63% bulls, a number not seen since late November 2001.
Then there's the Market Vane Bullish Consensus. This indicator is at its highest reading in more than a year (39%), but look at the chart to see how much more bullish it can become.
The Specialist Short Ratio and the Member Short Ratio are in the middle of nowhere and aren't showing extreme bullishness. And the
numbers from Chartcraft.com had quite a dropoff in the percentage of bulls last week.
By combining sentiment with the momentum readings (the oscillator), we can determine how this should unfold. The market has a correction from this extreme overbought reading, from the low VIX reading, from the too-many-bulls AAII reading, and finds support down below, which gives way to another rally.
Let's revisit late November 2001. That was the last time the AAII bulls reading was this high.
The market backed off in December, rallied into January, backed off in late January and February, rallied again in late February into March, and didn't come down in earnest until March and April 2002.
While I don't believe the next rally will unfold in exactly the same manner, I do think the first decline from such an overbought reading leads to another move higher. But because the market won't be oversold until the latter part of next week, it's too soon to be thinking too much about the next rally.
For more explanation of these indicators, check out The Chartist's
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Helene Meisler, based in Shanghai, writes a technical analysis column on the U.S. equity markets and updates her charts daily. Meisler trained at several Wall Street firms, including Goldman Sachs and SG Cowen, and has worked with the equity trading department at Cargill. At time of publication, she held no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. She appreciates your feedback and invites you to send it to