On December 13th, 2010, I penned a post which described how an abnormally overbought market is actually a bullish market, not a bearish one.
It is time to check in on the performance of that prediction.
You may recall I defined abnormally overbought as occurring when SPY closes above its upper Bollinger Band (built around a 50dma, with the upper band 2 standard deviations above the mean). Check out the post linked above for more information on this measure.
The graph below has been tracking performance of SPY since the original post, superimposed on top of the average performance of all abnormally overbought performances.
Right on cue, we see that SPY has reached its historical apex, where it has typically peaked in terms of gain and win percentage. If SPY continues to follow this historical trajectory, we will see some weakening and/or consolidation over the next 2 weeks.
While the past 40 trading days’ performance has been impressive, there have been 4 instances since SPY’s inception where the ETF gained more than +10% after this setup, with the largest from May to July of 1997 where it booked a gain of +12.35%.
Up next, per a reader request, I’ll look at what it means when the index closes above the top band of a 20,2 Bollinger
Band configuration (the default configuration). SPY closed above the top band on Monday and Tuesday.