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The Oversold U.S. Market Gets Even More Oversold

by: Toro January 18, 2008 | about stocks: SPX

Toro

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Thursday was just ugly. There is no other word to describe it.

I have been waiting for a bounce since the market is extremely oversold, but it does not come. Instead, bad news is sold and good news is sold.

One of the many metrics I use to gauge the market is moving average convergence divergence (MACD), an oscillator that gauges near-term buying and selling pressure. As you can see on the chart below, the MACD currently sits at -26, levels it hit on the July and November lows, both of which were followed by double-digit gains.

click to enlarge

This should mean a buying opportunity, right? However, the MACD hit -26 five times in the 2000-2002 bear market, and three times, the oscillator - and stocks - went much lower.

click to enlarge

The MACD hit -42 in March 2001, -49 in September 2001, and -45 in July 2002.

On March 2, 2001, the MACD hit -26. It proceeded to fall another 13% before bottoming on March 22. On September 10, the MACD again hit -26 again. During 9/11, the market proceeded to fall another 13% to its ultimate bottom on September 21. When MACD hit -26 on July 11, 2002, the market fell nearly 16% before reaching a low on July 24.

In all three cases, the market bounced at least 20% off the lows. The bottom occurred 15, 5 and 9 days after the low MACD reading.

There were two other times during the 2000-2002 bear market when the MACD was as low as it was on Thursday – in October 2000 and at the ultimate cyclical bear market low in October 2002. Both times, the market rallied.

Simply because we are at current oversold readings does not mean the market cannot fall further. However, it is likely that if the market does fall another 10%, it will do so fairly quickly.

Fear is seeping into the market. Don't be surprised if there is an intermediate Fed cut today, since it is options expiration day. If not today, then maybe next week as this market is in trouble.

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This article has 26 comments:

Jan 18 09:06 AM
Oversold - not exactly. Your technical indicators mean nothing in this declining market. Try some fundamentals, just for fun
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Jan 18 10:55 AM
I completely agree; try some fundamentals...
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Jan 18 12:30 PM
When did this bozo go long? NO ONE using these nonsense indicators makes consistent money. This bozo is yet another example. Bull Market genuis.
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Jan 18 01:23 PM
Don't you realize that were in the beginning of a world wide depression. The bond markets and insures are folding like a house of cards.
Equity markets will only be a very small % of their current value in a year. This is 1929 all over again. Yes, sadly to say history does repeat it self.
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Jan 18 02:34 PM
Watching the market all these years, my conclusion is that, often it does not follow the science or logic of economics; because it probably is controlled by the Big Money. When they are on the short side, the market goes down, even on a good news, because they have to make money. Then when they are pleased with the money they have made, they switch to the long side, and the market goes up. Small traders make money when they can sense the direction of Big Money, and get a piggyback ride.

But a lot of damage can happen when Big Money are on the Short side - they can manipulate to create a severely negative economic psychology, and panic in the country which can lead to recession, when the economic fundamentals may not be that bad to affect the whole country. The losers are the millions of average Americans; who may go through some economic hard times - because of layoffs, etc..

If you think the market is free here(to take its natural course), you may be wrong ! The Big Money is probably controlling its direction all the time to make money !

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Jan 18 02:52 PM
This article, especially the headline, seem uninformed at best, even foolish perhaps. Numerous unsupported statements are made throughout the article. In addition, it's a bit foolish to deliver a judgement about the broader market based soley on one indicator as the article does. Who was the anticipated audience of this article? Some journalistic rigor please.
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Jan 18 10:22 PM
I'm sorry, but a lot of these comments posted here are ill-informed. The writer in question never promised to provide a comprehensive overview of market trends. He states at the beginning that he is only going to focus on the MACD.

The posters here need to be less judgmental and more rational. People who rant and complain have no business making comments on market analyses - even if they feel the article in question is wrongheaded.

Say something useful or don't post. Or at least have the courage to post your name when slandering other writers' research.

Otherwise your opinion is worthless.
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Jan 19 08:58 AM
You lose money only when you SELL low. Without a question, the market will recover eventually. Just hang in there, hold on to your portfolio and be patient. DO NOT sell now.
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Jan 19 09:30 AM
Tuesday (1/22) will be an excellent entry point to play a ST bounce.

Those who read my blog know that I have been bearsish.

But now my indicators have turned ST bullish, and pessimism has increased dramatically.

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Jan 19 10:55 AM
Whew watch it all at INDU drop below 10,000.
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Jan 19 10:57 AM
I tend to agree with the author, not on the basis of the analysis, I don't put too much stock in tech analysis, however I suspect there is going to be a bottom reached shortly and a large hop.

One of the factors that people are not discussing, for some reason, is inflation. The Dow is basically where it was seven years ago more or less. However in real terms the dollar has inflated anywhere from 25-65%! Meaning that stocks, while PRICED at what seem to be still high levels, are in fact so devalued that I suspect big money will become bigger by buying up equities hand over fist.

The rich get richer and the poor get poorer.
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Jan 19 10:57 AM
Round numbers: The market peaked at 14,000. Now it's at 12,000. That's a 14% drop. A bear market can easily go down twice that: Dow 10,000. Three times (42%): possible, who knows: Dow 8,000. Tell me it's not possible.
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Jan 19 11:35 AM
Of course 8000 is possible. Just remember the figures are SO influenced by inflation that the current levels, in 2000 dollars, are probably 30% lower than they were in 2000. In other words, there has ALREADY BEEN a massive downswing, disguised by meaningless core CPI figures.

When the public finds out about a trend, the smart guys have known about it for six months to a year. Goldman Sachs started investing to take advantage of the CDO debacle a year ago. :) Now is the fear and loathing, when the small guys selll out at the bottom and lose their shorts one more time. The big guys will be buying.
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Jan 19 12:30 PM
I agree that bashing in some of these posts is unwarranted and reflects opinion and emotion more than any reasoned counterpoint. The guy who posts for peer review is commended for courage. I found the analysis interesting even though the caveats made it clear a bound or further decline can't be determined.

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Jan 19 12:30 PM
So, the $SPX bounced 200 pts off those MACD low points, in my book there's money to be made off that. Markets don't go straight down. The RSI is under 30, approaching the 25 level where it bottomed before. A rally is overdue next week, I think 1300 holds, which corresponds to Dow 12,000-11,800. Margin calls are triggering, that's all. Play the bounce, scalp only.
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Jan 19 04:19 PM
The pounding noise you hear is the sound of small investors, hitting the exits.
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Jan 19 06:51 PM
Let's be very blunt: The MACD is less effective than buy-and-hold by an order of magnitude over a generation. Those who use it do so in ignorance, willingly or otherwise.

What is most gaulling is that Seeking Alpha would allow ANYONE to publish an article with MACD as their reasoning for doing anything. The MACD is a ouija board for traders; nothing more. The fact that this website allows it to be used as a tool for anything is nothing short of appalling.
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Jan 19 08:06 PM
I just wanted to re-iterate this phrase

"One of the many metrics I use to gauge the market"

I was highlighting one of many.

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Jan 19 08:15 PM
Oh, and just to remind readers, most of what I right is fundamental. You can see the two links at the top on the left for other SeekingAlpha articles and at my site. I was trained at one of Canada's best buy-side shops which didn't even look at what the market was doing on any given day, instead looking deep into the company and financials back ten years and forward five. However, I have found that for short-term buying and selling, fundamentals are useless and what matters are the technicals. In the long-run, however, what matters most are the fundamentals. Technicals help you with your entry and exit points but fundamentals are why you invest.
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Jan 19 08:49 PM
The author is stupid. MACD is never, ever an oversold/overbought indicator. It is an oscillator. It has no highs, no lows, it can go anywhere. The only times to work the MACD are when it has a crossover, preferably under/over the 0 line, or when it has a divergence with the stock price. THERE IS ABSOLUTELY, UNEQUIVOCALLY, NEVER, EVER ANY TIME WHEN THE MACD INDICATES OVERSOLD OR OVERBOUGHT. That is novice information, and one should be ashamed to publish such a thing on a well known internet forum
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Jan 19 09:10 PM
Bill Shivers

You are absolutely correct. I did not phrase it properly.

For whatever you have used it for, I have found MACD and other technical indicators useful at extremes. I want to see many different indicators pointing at extremes. What I was trying to get across in the article was that MACD - and other indicators - may be at an extreme, but they have gotten more extreme in the past.

Apparently, judging by the comments, I did a poor job of doing so.
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Jan 20 03:20 AM
Toro - I would not apologize to any of these morons. I got your point. The MACD can go alot lower and we haven't seen the blue and red cross yet. When they cross it is often a good entry or exit point.

All - I think the big investors got caught flat footed this time (except Goldman) ...many Investment Banks and Hedge Funds have had their ass handed to them. I'm more than happy to take anyone's money who is stupid enough to stay long in this market.

Further, buy and hold is a good investment plan?? You gotta be kidding me! I think you could do something as simple as go short when the 200 DMA turns down and go long when it turns up again. This should return at least 50% more than buy and hold ...and there are MUCH better models out there!

Finally, I am sensing alot of sour grapes in these postings. Everybody is an expert in a bull market, but you actually get tested in a bear market. Suddenly everyone on CNBC, Cramer, Kudlow and the rest of the parade of bozos don't seem so smart anymore.
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Jan 20 06:40 AM
Toro,
First, a little disclosure. I was 100% cash 2 weeks ago. Today's it's only 65%. I bought a ton of INTC after miss. Also bought HD, LOW and JBL. Sold a bunch on bounce Friday. Now basically even and expect another buying opportunity, probably this week. I believe that is only a trade as we move into a bear market.

Now on your analysis. My opinion is best summarized this way. I've been a trader 8 years, full time 5 years. Over that time I have amassed substantial data of FA and TA. Thousands of files. There is also a collection of historical data. Perhaps 30 files. Your piece is now one of those. Very insightful. I would only add one comment. As in 2000-02, when the market rolled over the MACD extremes were initially more moderate. This past week might best compare to 2000 when only parts of the market had failed but many of the cheerleaders were trying to sell their spin. Then it was tech. Now it's real estate, financial and retail. But the overarching pattern is similar. So if this is correct, we get a bounce. Barring more bombs dropping first, could be very profitable. Then the highs are lower and the next leg down starts. More severe, lower lows. And tha pattern goes on.

One final note. The market is very emotional right now. That is reflected in some of the posts. This market can be unnerving. We need to stay objective.
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Jan 20 08:29 AM
Thanks for the comments.

I do believe that we are setting up for a very hard bounce in the near future. I just don't know if it is at these levels or 10% lower.
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Jan 20 10:20 AM
short sharp rallies at best in this market... 10 day moving average will pose great resistance to the upside and likely prove to be limit up. 20 day run? We'd need to see some great fundamental news like housing bust and recession cancel which is not going to happen. S&P 1300 getting much attention as a round number objective, but go back a few years and realize that a major bottom was put in at the 1220 range. WIth the insolvency problems we face, credit crunch, etc.. way too soon to look for a big market rebound. dot.com implosion should have taught everyone that markets can stay "oversold" for a long time.
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Jan 21 04:00 AM
People have a right to make foolish and ignorant comments. Quite a few over here. The author is too apologetic to them. There is always mutual discord between market technicians and fundamentalists. As a rule the latter wait too long. Market discounts future and by the time fundamentals show up it has already made a big move. What everybody knows, in particular, has little impact on prices. This applies to fundamental analysis primarily but also applies to technical analysis to some extent. Ultimately, one has to make a decision based on one's best estimate. Managing risk is more important than whether one has more faith in one method or another of analyzing markets. Besides technical and fundamental measures, there also are psychological and monetary indicators. Good luck to all!
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