Interpreting Oversold Conditions

How oversold is the U.S. equity market at this point?  One way to answer that is by looking at the Sector Bell Curve that plots the sector bullish percent charts for the 40 Dorsey Wright sectors.  A broad universe of U.S. equities is categorized into these 40 sectors.  The bullish percent for each sector measures the percentage of stocks in each of those sectors on a point and figure buy signal (short-term indication of positive trend).  The average of those 40 bullish percent readings (BPAVG) was 21.20% as of 1/20/16.  Visually, this oversold condition can be observed by the chart below which shows this sector bell curve skewed to the left hand side of the chart.

sector bell curve

We have data on BPAVG going back to 6/13/1997.  Over that period of time, only 1.5% of all measurements have been lower than today’s reading.  So, short answer is that the market is pretty oversold at this point!  The chart below of the S&P 500 highlights other times over this period where the BPAVG has been as oversold (or more oversold).

spx

Those months and years where the BPAVG has been this oversold (or more) since 1997 are highlighted in yellow: August-October 1998, January 2008, October-December 2008, February-March 2009, October 2011, and now January 2016.

A couple observations:

  • Some of those times when the Sector Bell Curve (BPAVG) was this oversold preceded tremendous moves higher in the broad market (1998, 2009, 2011)
  • Some of those oversold conditions preceded even greater losses in the broad market (2008)

The search goes on for the perfect indicator of a market bottom!  Actually, I’m not holding my breath.  Markets just aren’t that predictable.  With that in mind, I have a couple thoughts on how to proceed:

  1. Diversify.  A mix that appeals to me is 1/3 fully-invested momentum and value strategies, 1/3 Tactical Allocation, 1/3 Fixed Income.
  2. Add money to your investments when you get oversold conditions.  There is no guarantee that this type of oversold condition won’t get more oversold, but these types of conditions have often created great buying opportunities.
  3. Add other money to your investments on a regular basis no matter what the market is doing.  Is this at odds with suggestion #2?  No.  One of the biggest mistakes investors can make is to not save enough and waiting for “the perfect” opportunity to get in at the bottom can cost an investor a substantial amount of money over time.  Sure, for those inclined, use oversold opportunities to take advantage of what may be a great opportunity, but saving on a regular basis is essential to building wealth over time.

NOTHING CONTAINED WITHIN THE SITE SHOULD BE CONSTRUED AS AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY ANY SECURITY. THIS POST DOES NOT ATTEMPT TO EXAMINE ALL THE FACTS AND CIRCUMSTANCES WHICH MAY BE RELEVANT TO ANY COMPANY, INDUSTRY OR SECURITY MENTIONED HEREIN. THIS POST IS FOR GENERAL INFORMATION AND EDUCATIONAL PURPOSES. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. POTENTIAL FOR PROFITS IS ACCOMPANIED BY POSSIBILITY OF LOSS. 

10 Responses to Interpreting Oversold Conditions

  1. gerd says:

    strange that you’d comment on the market being “oversold”. shouldn’t you do the same then
    when it is “overbought”? why not let relative strength do its work and say nothing?

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