Thursday is looking like it will be the first three-day losing streak for the broad market in quite some time. Many stocks that you were hoping to buy a few weeks ago "if they ever pulled back" have now actually come down in price.
Not surprisingly, many of the same traders that were praying for chances to get into stocks cheaper are now hesitant to do so. That’s the conundrum of investor pyschology. Higher prices instill confidence that shares are going up.
Declining quotes often make us question our investment thesis. Falling stars also make it hard to pull the trigger, as waiting longer might result in even better entry points.
Two similar, but non-identical, indicators say you should be putting some cash to work right now. As of yesterday’s close the S&P 500’s 10-day advance/decline line was near the best levels (when used as a contrary indicator) since the exact bear market low set on March 9, 2009.
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I linked many of the most oversold time periods to their respective places on the chart of the S&P 500 ETF (SPY). Clearly, anyone with a reasonable time horizon would have been much better buying than selling once the cascades of panic had cleared the shares held in weak hands. I expect the current sell-off will lead to the same result.
The Overbought/Oversold Oscillator flashed an almost identical signal on the close Wednesday. Today’s action sent it to an even more extreme reading.
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The chart showing that indicator along with the S&P 500 is visually cluttered and hard to read. I added the exact same time period for the DJIA ETF (DIA) below the Oscillator chart for further clarity. I marked the five previously most oversold readings with stars. Four of those periods were followed quickly (within days) by major upturns in the broad market. The outlier, marked on the charts with the yellow star, saw a nice 30-day bounce that was then followed by a 45-day fairly significant decline. I’d call that signal a draw, rather than a miss. Six months later the indices were flattish. Twelve months later both indices were much higher.
Being completely right 80% of the time can make you a lot of money in this game. The trick is to think in terms of months rather than hours or days. What has changed fundamentally since mid-May to justify all the sudden negative vibes? Nothing much, unless you are basing your buy-sell decisions on Japan’s Nikkei 225 index. What will you do with the cash generated if you do sell your stocks? If you are like most traders you will simply put it back into equities again once some indicator tells you it is safe to get back in the water.
See my Value-oriented Model Portfolios [marketshadows.com]
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