Judging by anecdotal evidence, the market is widely regarded as overbought and in need of a pullback. Despite the concern, if and when such a pullback comes, most individuals intend to load the boat with stocks.
What no one bothers much to ask is what "overbought" actually means. According to Paul Hickey, co-founder of Bespoke Investment Group, there are a number of definitions, none of them etched in stone.
For Bespoke's purposes overbought is defined as markets, sectors or stocks trading well above their moving averages on a historical basis. Hickey uses standard deviations to control for the variability of stock volatility. For instance, when Netflix (NFLX) moves $50 above its 50-day moving average, that is less notable than if a utility does the same.
By that measure Hickey says stocks are overbought across the board. One of the few sectors that isn't overbought is Tech (XLK), but only if Apple's (AAPL) collapse is excluded. "At this kind of level you want to be a little bit more on guard," Hickey says in the attached video.
What most market watchers don't tell you is just how long these extremes can last before pulling back to the trendlines. "In early '09 we were extremely overbought for months," Hickey says, referring to the start of the rally that started at the begging of March and continues to this day. "On the flip side, in '07 and '08 were extremely oversold for months."
Overbought is a danger sign, but not what Hickey considers a "bell ringer." Treat your investments accordingly.
