S&P 500 High /Low Indicator Suggests Caution

May. 6.08 | About: SPDR S&P (SPY)

Here’s yet another market indicator which is suggesting caution. I’ve been noticing these pop up for a while now, and although we have now broken above the problematic resistance level of 1400, there are several reasons to reign in any rampant bullishness in the short term.

Among them, sentiment as well as the High/Low Indicator that I’ve mentioned before a few times. It measures and compares the number of highs to lows in the S&P 500 Index. It is a ratio of the highs to the sum of the highs and lows. So when it is a low number, we know that there are ample lows but little or no highs. And the reverse when it is a large number: many highs with few lows.

click to enlarge

Like many others, this metric is much better at pinpointing a bottom than top. This year has already brought two crazy oversold situations in the market. The first in January, and the second in mid-March. You have to remember the blue line in the above graph is a moving average, which means that we spent many days with a tonne of new 52-week lows, and zero 52-week highs.

At the same time, we aren’t yet pushing the other extreme. Clearly the extraordinary situation in early 2008 has been resolved and the S&P 500 has bounced back - around +10%. And even if the High/Low Index did get red-lined, it is no guarantee that the S&P 500 will instantly top out.

However, the important thing I take from this metric is that we no longer have that deep oversold condition from which to catapult higher. Been there, done that. The easy money has been made in that trade, and now the longs have to keep their wits about them.