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Market Rally Soon? - Extreme Oversold Levels

Sunday, November 18, 2012 EST

Typically traders look at things such as Stochastic or RSI to determine if a stock or the market is oversold.

RSI can be a good indication but another less widely used method is to use the percentage of stocks over the 50 and 200 day moving average. Currently only 16.4% of stocks are over the 50 day moving average.  Looking back in history we can see that this is typically an area when the markets starts to work it's way back up. 

The period around this time can be fraught with high volatility. This is good news for option traders.

The first chart below compares QQQ vs. the percentage of stocks over the 50 day moving average.  The yellow areas on the chart are considered "reversal zones" and clearly this past year the zones showed extremes in the market.  (interactive versions of the charts below can be viewed online)

 

This second chart compares the percentage of stocks over the 50 and 200 day moving average.  Again, notice where the extremes are on this chart.

 

Taking a longer term view on this 3 year chart it is still clear the yellow bands can indicate extremes in the market and a reversal is soon to come.  This chart also shows that many times these reversals are truly a battle between the bulls and bears and become volatile areas for trading.

 

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