When you are faced with a breakout rally like the one that U.S. stocks are enjoying just now, it's hard to think anything could go wrong.
Maybe nothing will go wrong, but Nvidia's (NVDA) 53% gain since April 15 is suggesting it's time to watch carefully.
Nvidia stock's Friday close at $131.88 put its relative strength index at 80. RSI is a measure of how fast a stock, a commodity or an index is rising — or falling.
Related: Why a veteran fund manager sold some Nvidia stock before its stock split
For Nvidia, 80 is a high reading and, more important, suggests the stock is overbought and could take a dive sometime soon.
It doesn't mean the company is having financial trouble. Nvidia is wildly profitable. Rather, it means too many investors are chasing too few shares, and something has to give.
That something will probably be that some buyers will conclude the stock price is too high and won't pay up. When that happens, the stock price will fall until investors see an opportunity, start buying, and equilibrium is obtained.
The basic evidence supports this idea. Nvidia shares are up 166% this year. And that's on top of a 239% gain in 2023. The stock may be ready to sag.
Many stocks are looking vulnerable
In fact, while the S&P 500 Index and Nasdaq Composite are at or near record levels, their recent gains are smaller than those of earlier in the year. The Dow hasn't achieved a new high since it closed at 40,004 on May 17.
At the same time, a host of big stocks are carrying RSI levels high enough to give investors' pause.
Related: Forget Nvidia, 'old tech' stocks are hot (and cheaper!)
The overbought list includes:
- Pharmaceutical giant Eli Lilly (LLY) , up 50.7% in 2024. Current RSI level: 78.
- Tech giant Apple (AAPL) , up 23.9% in the second quarter after a miserable first quarter. Current RSI level: 78.9.
- Retailer Costco Wholesale (COST) , up 29.6% this year after a 44.6% gain in 2023. Current RSI level 78.4.
- Chip designer Arm Holdings (ARM) , up 110% in 2024. Arm went public in mid-September and ended 2023 up 47.3%. Current RSI level: 80.
What the numbers suggest is all four stocks are overbought and and may be vulnerable to pullbacks.
RSI helps investors manage risk
Many investors care about RSI and other technical indicators because they offer signals on when to buy, when to sell and when to start the decision process.
In other words, RSI can help an investor cope with market volatility.
A reasonable way to think about RSI numbers is:
- An RSI above 70 means a stock is vulnerable.
- Above 75 means the stock price is rising beyond rational levels and a pullback is likely coming.
- Above 80 means a pullback will arrive — maybe within days.
The reverse is also true. If a stock is slumping, reaching the 30 level is a signal a bottom is coming. Under 30, a reversal is near; at 20, it's about to hit. That assumes the company is not in danger of failing.
Arm Holdings went public in September 2023. A month later the shares took off, doubling between the end of October and February. By then, the stock's RSI topped 90. But by April 15 the shares had fallen 41% to $87.19; the RSI was at 25.
The rebound began the next day: ARM shares have risen 81% since and the RSI is back to 80.
Indexes, even bitcoin, generate RSI data
Some companies whose shares are close to oversold or actually oversold include:
- Caterpillar (CAT) , down 12.3% in the second quarter, up 8.7% for the year. RSI: 30.6.
- ConocoPhillips (COP) , down 5.8% this year and 14.1% in the second quarter. RSI: 27.6.
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The methodology applies also to indexes, even bitcoin. As of Friday, the RSI levels for the S&P 500, the Nasdaq and the Nasdaq Composite Indexes and bitcoin were:
- S&P 500, up 13.9% year to date. RSI 72.3.
- Nasdaq Composite, up 17.8%. RSI: 77.4.
- Nasdaq-100 Index, up 16.8%. RSI: 78.6.
- Bitcoin: Sunday close $66,505. up 56.4% on the year. (Bitcoin trades 24 hours a day.) The cryptocurrency is down 9.5% from its March 13 closing high. RSI: 44.6. High RSI for the year: 87.07 on March 1.
In the 2008-2009 market crash, the signal of a major bottom came on March 9, 2009. The RSI levels for the Dow, S&P 500 and Nasdaq were all in the 20s.
Between then and the end of 2009, the Dow gained 59.2%, the S&P 500 jumped 78%, and the Nasdaq soared 78.9%.
Where to learn more about relative strength index
Calculating RSI is complicated.
The level can be found in the market data on a number of financial websites, including Yahoo Finance and The Wall Street Journal.
A decent explanation of it can be found in the Charts School section of Stockcharts.com.
In the meantime, keep an eye on Nvidia. The share price may dip. If you're a buyer, that means opportunity. Why pay more for a stock when you don't have to?
Related: Veteran fund manager picks favorite stocks for 2024
