Is The Stock Market Really Ready For A Reversal? Probably Not

Stocks have gone down for the 13th time out of the last 16 trading sessions.

Is there any sign of it stopping?  Nope.

Is there any reason to think we’ll reverse course?  Not really.

But the market is oversold.  You may say.  This is the time to buy - stocks are due.

Slow down.

This is still a bear market and until further notice stocks will behave bearishly.  In a bull market, they are behave bullishly.  In a bull market, when stocks are overbought, you may not want to buy, but it’s certainly not an indication to sell.  Overbought markets can remain overbought.  Similarly an oversold market may remain oversold.

Let’s start from the beginning - how do we know if a market is overbought or oversold?  For this, I like to use an oscillator.  One of the most popular is the Stochastic oscillator.  I will discuss this in more detail another time, but there are several different stochastics to choose from, but each will give you an indication of whether a market or stock is overbought or oversold.

Here is a look at the current market:

The market has been oversold for a while.  In the past this has led to short term bounces in the markets -even making it to the rarefied air of overbought for short periods.  The market now had been oversold for a longer period of time than in the massive sell off in September and November.  But oversold can stay oversold - there’s no technical rule that I know of that says an oversold condition will lead to a bounce. Now then, should it rise above 20 on the stochastics, that is a different story altogether.  But for now, we should not look for a bounce.  Let Mr Market give us a bounce.

Compare the current chart to the chart from two years ago.  In early 2007 the market was rallying.  We rallied so far that the market was overbought.  And stayed overbought for over a month.

To truly break out of an overbought or oversold condition, the indicator line has to dip out for more than a single day.  It has to dip out one day and then confirm the move on the next day.  Sharp sell-offs or rallies can skew the indicator - see the days in May 2007 the Tuesday rally from two weeks ago.

The market will tell us when it’s ready to rally.  Don’t be a hero.

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