"Your comments ahead of this week suggested a further sell off and it came on Monday. i have noticed that it can be some time before the market falls much after getting what you say is over bought. you must use more than this factor to trade for a decline? I have seen it take a long time before the market falls much and options expire before that happens."
Sure, the overbought indicator I tend to use a lot at least on the daily charts, the 13-day Relative Strength Index (RSI), can get into a 'typical' overbought zone above 70 and a correction happen some weeks later from still higher levels. However, once that indicator gets above 70 it often doesn't go all that much higher price wise but in terms of time, there won't be a tradable pullback for some time yet. And, if I haven't gone out very far in terms of expiration on any put choices or whatever strategy I'm using, I might not end up with any gain and I lose whatever I've put into the strategy. I do tend to go out at least 6 weeks when I'm looking for a counter-trend move (down) in what's been a strong advance like we've had. Still, it can be nerve wracking to wait and wait for the correction you're pretty sure is going to come but doesn't for days or weeks. Timing IS everything, especially in options.
I consider a prolonged high extreme in the RSI, either on a 13-day or 8 (or 13) week basis to set the stage for an eventual pullback but then will look to a stalling in a resistance area or a break of an hourly or daily (chart) up trendline to narrow in on the right time to possibly bet on a countertrend move.
Peak periods of the RSI are so often followed by a substantial pullback sooner or LATER, that studying this pattern over the years does tend to give confidence in when it's high risk to stay in bullish positions and when it's favorable, with suitable patience, to play the downside. Or, you could just use the thought of an 'inevitable' correction coming to wait to get back in to play the dominant uptrend.
The following table indicates what size corrections, if any (corrections didn't always follow), followed peak RSI readings since the current advance began in 2009.
I don't indicate how much higher SPX went AFTER the RSI peak for the period in question but I indicate when prices didn't fall after the 13-day Relative Strength Index high reading. Again, I don't advise using RSI alone as a sort of 'mechanical' sell 'signal' to exit bullish positions and/or to take a countertrend trade in a strong bullish trend.
The point I would make is that there have been some quite sizable sell offs that occurred along the way in the major bull market dating from March of 4 years ago and that those sell offs occurred after high RSI extremes, mostly above 70.
THE CURRENT TECHNICAL PICTURE
I used the following hourly chart in my recent Trader's Corner article of last week (2/21/13) as an example of being alert to WHEN the expected slow down and downside reversal might come.
There was a break of the hourly down trendline, followed by yet another rally (bull trends don't 'die' easily!) back to the previously broken up trendline, followed by a rally failure as this same trendline had 'become' resistance so to speak. I was looking for something more concrete and specific to suggest it was time to pull a trade trigger and bet on a pullback, AT LEAST (I figured) to the lower trendline. I'll update this chart to today's close next.
That the lower support (up) trendline on the hourly SPX chart was one where at least initial support would be found is borne out by the daily SPX chart seen following my updated hourly chart, which now reflects the most recent close (as of 2/26/13).
As to whether this recent correction has run its course, I can't say I have a solid take on that yet. The lower support up trendline of the SPX's daily chart uptrend price channel has been tested and, speaking of the RSI, the index has 'throw off' its overbought condition. Still, there could be more of a correction that is to come and I am not complacent about the bull trend immediately reasserting itself. Going by some other technical indicators, the trend is no longer in a clear cut up trend and the Dow had made a possible major double top, so there's more to see ahead.
Besides the rather 'simplistic' notion that the RSI and other such overbought/oversold type technical indicators was suggesting that the market was 'overbought' (duh!), the more defining suggestion of a top was the bearish price/indicator bearish divergence that developed as seen in my last chart, again with the S&P 500. Prices were going up on 'less' relative strength. The trendlines were graphically pointing in different directions.
Addition of the Rate of Change (ROC) indicator with 'length' setting also to 13, measures the rate of price change relative to X number of days ago. This indicator shows in another way, that while prices were going up they were going up on less 'velocity' or at a lesser rate of gain.
Moreover, the ROC indicator by the common definition of its measurement of the trend would 'define' the trend, on a 13-day basis, as down. SPX hasn't had that much of a retracement yet of the last advance and I'm not ready myself to jump back into the market on a bullish basis. I'll wait to see how the pattern unfolds in the coming days and next 1-2 weeks.
GOOD TRADING SUCCESS!