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I’ve been doing some thinking about the market, trying to peer into the fog and while tinkering with some charts, came up with this :
The candlesticks are the weekly Nasdaq 100 and the thin line the % of NDX stocks above their 50 daily moving average. Usually, when we have gotten an ‘oversold’ reading on the percentage of stocks above their moving average, we have seen a significant rally. Take a look at July 2004, for example.
But this has not always been the case. In January 2005 things were similarly oversold and after a tepid attempt at recovery, both metrics cascaded down again. It wasn’t until mid April 2005 that the market put in an intermediate bottom and began to rally.
So are we seeing the same situation repeat itself? Will the second bottom be the real one? Of course I don’t pretend to have a definitive answer. All I can offer are some ideas: yes, possibly but the general market - other than tech - is not as weak and can actually fall much further before hitting oversold levels. Also, if we are at a critical junction and seeing the switch from cyclical bull to bear, the things which we counted on before can simply stop working going forward. Oversold readings in bear markets are not at all the same as oversold readings in a bull market. Finally, you have to be wary of a market when an oversold condition doesn’t lead to some kind of rally.
Here is the same chart for the Canadian index:
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