Oversold enough for a bottom?

Mid-week market update: I wrote on the weekend that conditions were setting up for a panic bottom (see Here comes the sentiment flush), but one final flush may be necessary to spark a relief rally. The S&P 500 has now achieved the milestones for a panic bottom. The stochastic is sufficiently oversold. The index violated its 50 dma and it’s now filling the February 22nd gap after the strong NVIDIA earnings report, which represents a secondary support level.



The key questions are:
  • Is this a bottom?
  • If this is a bottom, is it a durable bottom or just a bounce before prices weaken further?



An oversold extreme

Subscribers received an alert yesterday that my inner trader had initiated a long position in the S&P 500. I saw the rare condition where every single component of my Bottom Spotting Model had flashed a buy signal within a three-day window.


Even in isolation, the extreme oversold conditions seen in the NYSE McClellan Oscillator and the intermediate term overbought/oversold model have been strong signals of short-term bounces.



In addition, the Zweig Breadth Thrust Indicator has reached an oversold extreme. In the past 10 years, such conditions have always resolved in relief rallies.



Jason Goepfert of SentimenTrader observed, “Out of 17 times the VIX jumped from ultra-calm conditions, only 1 led to more than a 10% loss within the next 3 months for the S&P.”



Nautilus Research found that the future returns from similar one-year analogues were strong.




A durable bottom?

Still, there are nagging doubts that even if the market were to bounce, that this represents a durable intermediate-term bottom. Helene Meisler acknowledged that short-term indicators are very oversold and a relief rally is imminent. However, longer term indicators like the Citi Panic/Euphoria Model is still at a euphoric extreme. To be sure, this model is designed for a one-year time horizon, but its overbought reading is suggestive of further choppiness after a price bounce.



Here’s what I do know. The stock market is extremely oversold and short-term sentiment is fearful enough that a decent short-term rally is imminent. Whether the relief rally represents just a blip before prices weaken again is a matter for debate. We need to watch how stock prices behave as the market rallies in the coming days.


Both my inner investor and inner trader are bullishly positioned. The usual disclaimers apply to my trading positions.

I would like to add a note about the disclosure of my trading account after discussions with some readers. I disclose the direction of my trading exposure to indicate any potential conflicts. I use leveraged ETFs because the account is a tax-deferred account that does not allow margin trading and my degree of exposure is a relatively small percentage of the account. It emphatically does not represent an endorsement that you should follow my use of these products to trade their own account. Leverage ETFs have a known decay problem that don’t make the suitable for anything other than short-term trading. You have to determine and be responsible for your own risk tolerance and pain thresholds. Your own mileage will and should vary.



Disclosure: Long SPXL