Over the last couple of days, Iâve received a few emails regarding S&P 500â˛s sell off and whether or not the index has become oversold. This is obviously a difficult question to answer, because a) indicators can be very subjective depending on the market trend; and b) it depends on whether you are a short term trader or a long term investor.
While there are many indicators that signal overbought and oversold readings, Iâm a going to list a few I follow on the US stock market. I obviously couldnât list all of them, as this post would be very long, but these 10 can give you a good idea of what is happening right now.
Chart 1: Technical RSI level never fell below the 30 oversold level
Source: StockCharts (edited by Short Side of Long)
- The basic bread and butter of technical analysis is the Relative Strength Index, also known as the RSI. Readings above 70 indicate overbought levels, while readings below indicate oversold levels. In the chart above, we can see that the Daily RSI never went below 30. The same story is true for the weekly and monthly RSI levels, both of which are actually at or near overbought levels. Side note: this indicator behaves differently during sideways price action compared to a trending market.
Chart 2: However, over 27% of the S&P 500 stocks traded below RSI 30
Source: index indicators (edited by Short Side of Long)
- However, just because the index itself didnât become oversold, does not mean some of its components didnât either. The chart above shows that over 27% of the S&P 500 companies traded with their respective RSI indicator below 30 into the 01st of February. Is this oversold enough? That is a subject call and it depends on the strength of the current uptrend. During the November 2012 low, just as the powerful uptrend began, readings only got to above 20%. However, during the August 2011 crash, we saw almost 90% of stocks trade below RSI 30.
Chart 3: Index price fell sharply trading more then 2SDs away from 50MA
Source: BarChart (edited by Short Side of Long)
- Into the 01st of February, the equity index price traded more then 2 standard deviations below its 50 day moving average, also known as its mean. This is definitely considered as a short term oversold level and a reason why there is a bounce occurring as I write this post. Readers should note that this is the first time S&P 500 has traded more then 2SDs below its mean in over a year.
Chart 4: Percentage of stocks above 20 MA reached an oversold level
Source: index indicators (edited by Short Side of Long)
- One of the favourite indicators I use to track short term oversold readings is percentage of stocks trading above the 20 day moving average. Essentially, when we have only 20% or less of the overall index share components trade above 20 day MA, the market becomes oversold in the short term and primed for a rebound. We are currently in the midst of the rebound right now.
Chart 5: However, stocks above 200 MA is not even close to oversold yet
Source: Short Side of Long
- However, if we use the longer term gauge, where we track percentage of stocks within the index trading above the 200 day moving average, we can see totally different condition. The market has been overbought for the whole of 2013 as the uptrend was virtually uninterrupted. Oversold readings are also reached around the 20% level, just like in Chart 4, however this indicator is no where near a buy signal yet. I imagine that S&P 500 would have to drop by at least 15% to 20%, before we readings in Chart 5 dropped to 20% or less.
Chart 6: Two week average of Advances vs Declines become oversold
Source: Short Side of Long
- Breadth can be tracked in numerous ways. So far I have covered percentage of stocks trading at RSI below 30 and percentage of stocks above both the 20 and 200 day moving averages. In Chart 6 we are looking at a two week average of NYSE advancers minus decliners. Clearly, this indicator is pointing to a short term oversold level, with most of the decliners and down volume dominating market conditions in the short term. having said that, selling intensity is not even close to the extremes as we saw during late 2008 and mid 2011 bottoms. Those were âextremelyâ oversold.
Chart 7: Monthly average of 52 Week Highs vs Lows isnât oversold yetâŚ
Source: Short Side of Long
- The final breadth indicator to cover in this post for the purpose of oversold levels, is the NYSE 52 Week High Low ratio averaged over one month or four trading weeks. It is very interesting to note that this indicator has not reached a 20% threshold in well over two years now. In other words, the stock market hasnât had a proper corrections, where new lows dominate new highs, since October 2011. We are eventually its overdue for one, that is for sure!
Chart 8: S&P 500 isnât even trading below the 200 day moving average
Source: Short Side of Long
- When we talk about oversold, usually one of the first question that comes to my mind is how far is the asset trading below its long term average? The chart above shows the S&P 500 equity index against its own 200 day moving average (also known s the long term average). The answer to the question above is that S&P is still over 3% above its long term average (as of Thursdayâs close). Obviously, this indicator is subjective to a degree. You can see that during bull markets (uptrends), oversold levels arenât anywhere as damaging as they are during bear markets (downtrends). Having said that, true oversold conditions were seen in mid 2001, early 2002 and late 2008.
Chart 9: Annual performance of US equities is not even close to oversold
Source: Short Side of Long
- Price performance is one of the best indicators to gauge when it comes to overbought and oversold conditions for all asset classes. This indicator tracks the rate of change between the current price and the price several days, weeks, months or years ago (depending on your preference). Annual performance chart presented above, shows that the US equity market has not posted a negative return for almost 5 years (since the 2009 low). While observing the the markets almost vertical advance in recent quarters, we cannot really call it oversold⌠can we? Maybe the correct term would be that the market is still quite overbought.
Chart 10: Stocks are slowly getting closer to oversold relative to bonds
Source: SentimenTrader
- The final indicator comes from the SentimenTrader and it tracks the relative valuation between stocks and bonds over the short term. The indicator readings are presented in standard deviations format and oversold conditions are usually seen at or below the level of 2. During the last days of January, we got quite close to that level. Nevertheless, this indicator hasnât been oversold since June 2012.
