Wednesday, August 06, 2014

How Oversold Are We in the Stock Market?

Hats off to the excellent someecards site for many useful psychological perspectives!

So, in the spirit of being both anxious and well-educated, let's ask:  How oversold are we and what has that meant in the recent past?

I noticed on the Index Indicators site that we have fewer than 30% of SPX stocks trading above their 50-day moving averages.  That is pretty rare for a sub-20 VIX market.

Indeed, going back to 2006, we've only had 11 non-overlapping occasions in which fewer than 40% of SPX shares have traded above their 50-day moving averages during a sub-20 VIX market.  Those dates were:  7/14/06; 3/2/07; 6/3/11; 4/13/12; 6/26/12; 10/24/12; 6/21/13; 8/27/13; 10/9/13; 1/24/14; and 4/11/14.  When we look 20 days forward, the cash SPX was up 9 times, down twice for an average gain of 2.98%.

I then looked at first time occasions in a month (same non-overlapping criteria) in which we registered fewer than 30% of stocks trading above their 50-day moving averages in a sub-20 VIX market.  It hasn't happened since 2006.  In the past week, however, we've seen two such readings.

When I extended the search to markets in which VIX < 22, then there were seven non-overlapping occasions in which fewer than 30% of stocks traded above their 50-day moving averages.  Four were up after 20 days and three were down.  Several of those occasions took place relatively early in the process of larger market selloffs:  7/22/08; 6/15/11; and 5/14/12.

Buying dips in market uptrends (low VIX) has generally brought positive returns.  When dips fail to sustain a bounce, however, it's one early sign that markets that are oversold on shorter time frames are in the process of becoming oversold on longer ones.  At least with respect to sub-20 VIX markets in recent market history, this market is not only oversold, but uniquely so.  

Further Reading:  Tracking Market Strength and Weakness
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