Thursday, September 24, 2009

Passing The Plate: Shift From Oversold to Overbought

If you recall, my "passing the plate" post requested perspectives from readers regarding trading patterns that they were utilizing.

Here, Babak of the Traders Narrative blog responds by offering his historical perspective on what has happened when the stock market has gone from being far below its moving average to being far above in a short period of time. As the chart above and Babak's post indicate, we have gone from being a record amount below the 200-day moving average to near a record amount above.

Momentum peaks often precede price peaks and similar vertical rises from oversold to overbought, such as after the sharp drops in December, 1974; October, 1987; and March, 2003, led to rises that lasted well over a year in duration before a new bear market ensued. As the Traders Narrative piece indicates, however, not all shifts from oversold to overbought have led to sustained gains.

This research is very much related to a pattern reported by Rennie Yang of Market Tells, pertaining to the S&P Oscillator. That indicator tracks changes in overbought/oversold conditions via daily advance/decline figures. It has given very positive readings lately, reflecting the sharp move from very oversold to overbought conditions. As Rennie notes, such positive readings have generally led to further price strength in the intermediate term.

Thanks to Babak for highlighting this pattern. I will be posting additional patterns and setups from readers in coming days.