In broad rally, most sectors of TSX overheating

Virtually every sector of the Canadian equity market is dangerously extended. While conditions can change very quickly, technical indicators suggest a low probability of success for most traders and short term investors.

Professional traders depend heavily on technical analysis precisely because market conditions change rapidly. Sectors and stocks that are hugely oversold and poised for a rebound can move to a dramatically overbought danger zone in a matter of days, though the opposite is also true – the technical environment described here could be completely outdated by Thursday. Investors with a longer time horizon generally don't have to bother with the technicals; the exceptions are cases where longer term investors are looking to add a new positions or sell an existing investment.

Whatever your approach, technical indicators like the Relative Strength Index have proven remarkably adept at signalling entry and exit points for sectors and stocks. The first chart highlights that for the Canadian bank sector specifically, the average return when RSI climbs above the 70 sell signal (the grey line on the chart), the average performance for the following three months has been a disappointing -0.57 per cent.

The second chart shows that of the 23 subsectors of the Canadian market (GICS level 2), fully 13 are well above the RSI 70 level that suggests overbought, technically extended conditions. Four more subsectors are hovering just below overbought levels between 65 and 70. None of the subsectors is showing a 30 or below RSI that would signal an oversold or attractive technical reading. The S&P/TSX Software Index is, however, close at 31.1.

Long-term investors can safely discount technical analysis in most cases, content that fundamental analysis and a focus on valuations will protect them from the vagaries of short term strategies. For short term traders, including professionals, technical analysis remains paramount and the more astute among them will be reducing positions as overbought conditions continue.