The Stock Market Is… Oversold?

Published October 10, 2017 - 7:30 AM

Well, this is interesting…

The S&P 500 closed at an all-time high near 2552 last Thursday. Yesterday, the index closed at 2545 – just seven points below the high, or a two-day loss of about 0.27%. Yet, some of our key technical indicators are already oversold.

That’s right… OVERSOLD.

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The McClellan Oscillators for the Nasdaq (NAMO) and New York Stock Exchange (NYMO), for example, both closed below their lower Bollinger Bands yesterday. Take a look…

The McClellan Oscillators help to identify overbought and oversold conditions. Bollinger Bands indicate the most probable trading range for a chart. So, when the oscillators trade above their upper Bollinger Bands, we have overbought conditions on the Nasdaq and NYSE indexes. When the oscillators drop below their lower Bollinger Bands, the indexes are oversold.

The blue circles on the charts above show the five times this year when both oscillators dropped into oversold territory at about the same time.

Here’s what happened to the S&P 500 following those occurrences…

On all four of the previous occasions, the S&P 500 rallied immediately. In three of the four previous times the oscillators were both oversold, it marked the absolute bottom of a short-term decline phase for the market.

Given this history, traders need to be open to the possibility that the small, two-day, 0.27% decline we just saw might be all the decline we’re going to get for a while.

Stocks don’t have to move sharply higher from here. Frankly, I doubt that they will. But it sure doesn’t look like we have the sort of setup that’s going to lead to a sharp correction from here in the short term.

For the past few weeks, I’ve been skeptical of the market’s rally. But I’ve also been reluctant to add any short exposure because we just haven’t seen a low-risk setup for such a position. Given the oversold condition of the McClellan Oscillators, we still don’t have that setup.

Best regards and good trading,

Jeff Clark

P.S. Will you be taking advantage of these conditions in the trading day ahead? Let me know your thoughts, questions, and suggestions right here.

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Hi Jeff, you are truly a master indeed. What about selling uncovered calls on auto loan subprime lenders like CACC and SC? They look like quite in oversold territory.

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The stock market has been hard to read for a while. I have started using the EUR/USD as a measure for dollar strength. You are looking at GDX as overbought and ready for a bounce up. This is while gold itself is down and the EUR/USD has more weakness down to $1.14-1.15. Then I expect the bounce up to at least $1.20-1.22, a significant move, which should be accompanied by gold strength and stock market weakness.

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Hi Jeff, I'm trading with a $100k portfolio. How much should I risk per recommendation? I currently risk $2k per trade. Is this too little? 

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Editor’s note: Harry, see this essay for Jeff’s insight on position sizing. According to him, “You should only have 2%-3% of the money you’ve set aside for trading at risk on any one trade.” So, you’re right on the money…

On my way through the historical literature, I was reading the May 23, 2017 Delta Report dealing with SMH and MCD. It referenced in sequence over several pages two SMH charts and one for MCD. However, the first chart was for CCJ, the second chart was for TEVA, and the third chart was for HYG? Are the appropriate SMH and MCD charts available? Thank you.

 David

Well spotted, David. This error has been fixed. Thank you for bringing it to our attention.

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