Are We Significantly Oversold In The Stock Market?

Above is a useful short-term measure of whether we are trading in an "overbought" versus "oversold" mode in the U.S. stock market.  The blue line is the cash SPX; the red line is a five-day moving average of the following:

(5-day new highs minus 5-day new lows) + (20-day new highs minus 20-day new lows) + (100-day new highs minus 100-day new lows)

The new highs and new lows are taken from the SPX stock universe only (raw data from the excellent Index Indicators site).  

Going back to 2010, when we've divided the readings into quartiles, the next three days in SPX for the most oversold quartile have averaged a gain of +.58%.  The average three-day change for the other quartiles combined has been +.01%.  Superior returns for oversold market conditions are noteworthy over the next 20-day horizon.

What makes the current time period particularly interesting is that the same indicator constructed for the 600 SP small cap stocks is not showing the degree of oversold reading we're seeing among the large caps.  For example, about 17% of small cap stocks made fresh 20-day lows yesterday, compared with 28% of large caps.  That discrepancy itself, hinting at the breadth of weakness across sectors, is itself useful information.

Further Reading:  Unique Views of Breadth and Strength
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