After the price breakdown in late-July, some internal indicators quickly became oversold in the short-, medium-, and long-term, and have stayed there for nearly a month. This fact is clearly illustrated by our indexes of stocks above their 20, 50, and 200 exponential moving averages (EMAs). I like these indicators because they are straightforward and easily understood.
When the market is oversold in a bear market, our first concern should be that prices, rather than advancing, will slide even lower because the buyers have left the building. That doesn’t mean that the market can’t rally. It does mean that the market is less likely to rally, and, when it does, the rally is likely to fail. On the left side of the chart I have annotated a portion of the last bear market, which illustrates dismal price performance in spite of oversold indicators.
Bottom Line: Indicators need to be interpreted wthin the context of the overall market trend. Currently the market is oversold in a bear market, so the best we can hope for is a rally that will fail before it can make new highs. That we have seen the final low of the bear market is unlikely because bear markets usually last longer than this.
(This is an excerpt from August 26, 2011 issue of the blog for Decision Point subscribers.)
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