Maybe.
Sometimes that happens.
But is that truly a trade-worthy idea?
Yesterday, we saw fewer than 10% of all stocks in the SPX average trading above their three-day moving averages. The market is broadly weak in the short run. Interestingly, when we look at how the SPX stocks are trading relative to their 5, 10, 20, 50, 100, and 200-day moving averages, well fewer than 50% are trading above those benchmarks. So we're very oversold on a short-term basis in a market that is also oversold on a medium and longer-term basis. (Data from the excellent Index Indicators site).
It turns out that this configuration has occurred 46 times since 2010. Ten days later, the SPX has been up 33 times and down 13 times for an average gain of over +1.63%. Many of the losing instances clustered in the 2011 period when we had some prolonged weakness. Similarly, when we take the data back to 2006, losing instances clustered in 2008/2009, so that there was a positive return over the next day or two from 2006-2009, but actually a negative average return over the following ten days.
There is a subtle but important lesson here. The human tendency is to make an assumption about whether we are in a bull or bear market and then extrapolate expectations on that basis. A better use of the data is to recognize that the kind of pullback we've seen is historically a very good buying opportunity in all but significant bearish periods. If we do not see a sustained bounce as we walk forward day over day, we can update our thinking to increase the odds that perhaps we're in the throes of a bear. Conversely, if we see sustained buying, we can question the bear thesis as we walk forward.
Rational traders and investors operate in a Bayesian manner. They start with a researched base case founded on experience and then keep an open mind, modifying the odds of their base case as new data emerge. For them, conviction is a process, not something we have or don't have.
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