Sunday, February 28, 2016

A Useful Overbought/Oversold Measure for Stocks

I encourage readers to check out the most recent Forbes post, detailing how a common information-processing bias has led to poor trading returns in the last year or two.  When we make decisions as much for psychological reasons as logical ones, we become vulnerable to drawdowns. 

Above is the five-day indicator described in the Forbes post.  It is unique, in that it tracks strength across six technical indicators and then sums up across all NYSE stocks.  As documented in the post, using this as an overbought/oversold measure has been helpful to entry and exit execution for longer-term positions and has also helped active traders avoid chasing recent returns.

Note how we've had a vigorous rally off the February lows and are now coming off overbought levels with price holding up relatively well thus far.  This is not too different from what we saw after the September, 2015 and October, 2014 lows as, early in a market cycle, we don't see the pronounced mean reversion present at other points in the cycle.

I will update this measure periodically.

Further Reading:  The Trading Bias Killing Recent Trading Returns