While the stock market made a dip to start this year, I explained that move by simply noting that the market simply came into this year in an extremely overbought condition after having rallied in November and December with hardly any pullback at all. In fact, the RSI technical indicator, which measures oversold and overbought readings, registered it’s highest overbought reading in about six years!
Overbought conditions like that get worked off with a drop or a sideways consolidation phase, and the latter is what we have really seen in the market in this first half of January.
Now earnings season is kicking off this week and this sideways consolidation pattern has set the stock market up to make a big swing this week.
Take a look at this chart of the S&P 500 and you’ll notice that it’s 20-day Bollinger Bands indicator (the two pink lines enveloping the price plot) are coming together. The 20-band width indicator on the bottom of the chart is now at it lowest level in three months.
What does this mean?
The Bollinger Bands measure price volatility and when they contract it means overall price volatility (over a 20-day period when using 20-day Bolllinger Bands) has shrank. The moves up and down when this happens are just noise.
A contraction in the bands, as they are now, sets the stage for an expansion in the bands.
That means volatility – pure sustainable price movement – is set to increase very soon.
Now you can read the math behind the bands and more of the details about them with a handy article from Investopedia you can find here.
What we are seeing is a classic Bollinger Band “squeeze” pattern with this S&P 500 chart.
In other words – the stock market has been going sideways now for about twenty days and that sideways pattern is likely to be broken this week.
Now this setup doesn’t tell you in what direction the move will happen – only that a move is likely to come.
Will the S&P 500 breakout to new highs for another spurt or dump hard down to it’s 50-day moving average?
This setup is not just happening with the S&P 500, but with many of the sectors inside of it.
One I have focused on a lot recently is the REIT/real estate sector.
Take a look at the RWR ETF and you’ll see the same pattern as you see with the S&P 500 now.
Of course, I have noted in a few emails how this already has been setting up with PDM, a stock I own.
So, which way do you think the market will move?
My guess is up, because we’re still in a cyclical bull market, which began at the end of 2022..
Stocks also typically go up when earnings season starts and make a short-term momentum peak in the second half or end of earnings.
But, we’ll see.