Overbought Territory?

I have a diffusion indicator I use, and it’s telling me we’re probably near the peak of the current short-term rally. Is it predictive? Sometimes. Except when it’s not.


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Click to enlarge.


This is calculated by recording the diffusion ratio of all the stocks in the Russell 3000 index that are up 20% or more in 20 days, vs those that are down 20% or more in 20 days. [ up ÷ (up+down) ] I then calculate a short-term momentum function to generate the curve you see in blue. Overlaid with this in red is the SPY ETF price, a proxy for the S&P 500. Note that when the blue line dips below .75, everything seems to go pear-shaped in the days following.

Add to the fact that some of the indexes have hit all-time highs today, and, well…

Time to hang up the short-term momentum trades and prepare for the short-term mean-reversion trades instead!

No mo' momentum, yes mean reversion!
No mo’ momentum, yes mean reversion!