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The S&P/TSX Composite is now technically overbought and vulnerable to a pause or correction in the short term, according to Relative Strength Index (RSI).
The benchmark climbed into frothy territory with a 1.9-per-cent weekly return for the trading week ending with Thursday's close. The RSI reading is now 71.4, above the sell signal of 70.
In terms of individual index constituents, there are only three stocks trading at attractive oversold levels below the RSI buy signal of 30. TransAlta Renewables Inc. is the most oversold stock in the index, followed by Corus Entertainment Inc. and Detour Gold Inc..
The focus chart this week uses the benchmark itself in an attempt to assess how concerned investors should be about a significant correction. The good news is, probably not much.
RSI sell signals (readings above the RSI sell signal of 70 represented by the light blue line on the chart) have been effective in predicting short-term pauses or declines in the S&P/TSX Composite. A sell signal in February 2015 was followed by a 4.0-per-cent drop and another sell signal in April 2015 presaged a much bigger fall of 23 per cent to January of 2016.
RSI sell signals in March and April 2016 predicted insignificant pauses in index performance. The sell signal in early June 2016 forecast a brief 2.5-per-cent correction. The last half of 2016 saw a few sell signals that the market basically ignored, not even slowing its march higher.
The most recent RSI sell signal was in February 2017 but the ensuing path of benchmark performance was only marginally weaker, and not for long.
The current sell signal coincided with the index rising above its 200 day moving average trendline, which is very positive and potentially indicative of a sustained uptrend (if it can stay above the trendline).
The past three years shows that RSI sell signals should be taken seriously as a 'wait and see' indicator. For stocks that dominate index performance, investors should wait to add significant new positions for as long as overbought conditions persist. RSI is a very short term indicator, and the numbers can change quickly from overbought to oversold.
As always, fundamental analysis could provide a different story for individual opportunities, and investors should always complete fundamental research before making any market transactions.
The list of overbought index stocks is huge this week at 36 members, which we'd expect given strong benchmark returns. Toromont Industries Ltd. is the most overbought stock in the index followed by Cenovus Energy Inc., Canadian Western Bank, Great Canadian Gaming Corp., TD Bank and Paramount Resources Ltd.