Saturday, November 22, 2008

A Historically Oversold Market

This past week, the Dow Jones Industrial Average traded about 34% below its 200-day moving average. This eclipses the oversold conditions from the post WWII era. Indeed, as the chart above indicates, since 1902 we've only had one period of greater oversold conditions: the Depression market of 1932. Looking for market bottoms using historical analogues from modern markets has been hazardous to investors' wealth.


myinvestorsplace said...

Oversold markets are tough to time. The problem is that sometimes, oversold markets simply get more oversold, and then you are quickly underwater on the buys you make.

MyInvestorsPlace - trading, value, investing, forex, stock, market, technical, analysis, systems

David L. Spurr said...

We will bottom at some point. If you're a longer term investor, you need to go with the odds and start building positions now. I think about dividing up your potential desire for equity exposure into 1/10's and gradually start buying ; There's been no better opportunity to start getting long in the last 75 years. Risk management it key though......

David said...

Time horizon is everything, isn't it?
Still, calling this a once in a 75 year opportunity may be more than a little hopeful since little of the previously underlying leverage is coming back anytime soon.

beeba said...

First time posting, so I want to thank Brett for committing so much time and effort to this weblog. Brett - your books kick ass - especially "Enhancing Trader Peformance". I'm taking simulation very seriously after reading your book, much more seriously than before. Thanks for opening my eyes to the concepts of structured practice. And thanks for the information about the tick - I read through that carefully last night, and it blew my mind. I'll never trade without it again.

As far as this thread is concerned, I'm not so sure it's time to buy. Although we're quite oversold, we're still not showing any market strength on daily and weekly charts. For example, we haven't had a bullish moving average crossover on a weekly chart of $indu since before this entire disaster started (the last crossover - in december 2007 - was bearish).

One thing that I did notice this time around was some divergence between rsi and price volume on a daily $indu chart ($indu20081121.upsideReversal.png)
To me, divergence between price and other indicators is always noteworthy. We may end up with a short-term pop over the next couple of sessions.

However, for long-term investors, I see no need to start building positions now. I'd wait until I saw a weekly reversal on the charts and simply commit more money to the positions than trying to pick the bottom when weekly charts are still showing downtrends. At the very least, we should wait until volatility comes off its highs and treasury yields increase. People are running scared right now, given the yields on short-term U.S. government paper.

I was looking through the some charts on the last bottom in 2002, ($indu2002.bottom.png) and I noticed that as the market bottomed, a couple of things happened

* volatility receded substantially

* the market closed above the 20-day moving average for several sessions, and a bullish moving-average crossover subsequently occurred on the daily and weekly charts. price action traded above the 10-day moving average for a subsequent up leg.

* buying action was sustainable - in that buying brought more buying into the market.

Until we see volatility drop off and until buying quits bringing more selling into the market, I'm not willing to go long unless it's purely speculative (which is fun).

(Brett - please let me know if this is too long and I'll trim it up. Also, I had trouble submitting it, so the comment may come in twice. ugh.)


David L. Spurr said...

I will not be able to pick the ideal bottom. We will not know for sure that the market has turned ....for good. This will only become evident when the market is approaching 12,000 after numerous fits and starts. The buying at this level could be early, but that's a risk I'll endure. This have not been this cheap in my lifetime. Things will improve - somehow. Nobody wants to buy when we're close to the bottom. Majority of those I speak with think we've got much lower to go......possibly. Again - It's a risk I'll endure.

The Stock Speculator said...

I am not sure why everyone try's to get underneath a falling knife in order to catch it? What is the hurry to lose money?

We are in uncharted waters here. Why not pay up a little bit and wait for some sort of confirmation before making an investment?

I look at it like insurance, I'll let someone else take the additional risk for a smidge better return. In the scheme of things the added risks amount to picking up nickels in front of an oncoming bus. It's just not worth it.

As everyone has already stated, oversold can just get more oversold.


Brett Steenbarger, Ph.D. said...

Thanks for the perspectives and thanks, Stephen, for the kind feedback--