Investors in Caterpillar (CAT) enjoyed a huge turnaround in fortunes last year…

From its low in late September, CAT rebounded strongly, finishing 2022 at a yearly high. It was also at its highest level since May 2021.

However, that strong move higher pushed CAT into overbought territory.

After rolling over and reversing, CAT was stuck in a downtrend when we last checked in on it on April 6 (red arrow in the chart below).

Even a big earnings beat later in April couldn’t stop its fall.

But CAT has recently turned higher. And today, I want to see what’s coming next…

Breaking Out of a Downtrend

In the chart below, you can see CAT’s huge rally at the end of last year.

In late September, the Relative Strength Index (RSI) formed a ‘V’ and rose from oversold territory (lower grey dashed line). That kicked off CAT’s surge higher.

Caterpillar (CAT)

Source: eSignal

The 10-day Moving Average (MA, red line) then broke above the 50-day MA (blue line). And both tracked higher. That served as further confirmation of the rally.

You can gauge the strength of that up-move by the steep angle of the 10-day MA’s cross above the 50-day MA.

But CAT’s rally stalled in late January with a common reversal pattern…

While CAT was making higher highs (upper orange line), the RSI was making lower highs (lower orange line).

That drop in momentum pulled CAT lower…

CAT continued to fall as the RSI broke down through support (green line). And the 10-day MA bearishly crossed back below the 50-day MA.

As the chart shows, even CAT’s 31% increase in Q1 earnings per share (EPS) wasn’t enough to bring in fresh buying momentum.

Take another look:

Caterpillar (CAT)

Source: eSignal

With the RSI firmly stuck in the bottom half of its band (red oval), CAT drifted lower before recently breaking out of its bearish pattern.

CAT’s burst higher coincided with two bullish signals:

1. For the first time since March, the RSI broke back into its upper band and is currently tracking higher.

2. The 10-day MA also broke back above the 50-day MA, with the 50-day showing promising signs that it too could be turning higher.

But with that surge also pushing the RSI toward overbought territory, what can we expect from here?

An Emerging Rally

Just because a stock is in or near overbought territory is no guarantee that it will fall.

When the RSI peaked and tracked sideways in overbought territory in November last year, CAT traded sideways too.

CAT’s rally resumed when the RSI rose higher off support in December.

If a similar pattern repeats now, that could provide the setup for CAT to continue to rally. Beyond that, a prolonged stay by the RSI in its upper range could set CAT up to take out its January high.

For such a move, we’d also want to see the 10-day MA accelerate above the 50-day MA.

Right now, though, we need to keep a close watch on what happens with the RSI…

If the RSI forms an inverse ‘V’ and makes a decisive move lower, then CAT’s emerging rally could come to an early end.

Regards,

Larry Benedict
Editor, Trading With Larry Benedict

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