Measuring Oversold Conditions in the Stock Market

My friend Ari Wald put out a great note this morning in regards to the ongoing consolidation in equities. He's watching the percentage of S&P1500 stocks trading above their 30 and 200 day moving averages to give buy/sell signals. When these measures dip below certain levels, he thinks that tactical traders can use this oversold condition to accumulate shares.

We're not quite there yet:

"Recent consolidation in the equity market has dropped the percentage of S&P 1500 stocks above their 30-day moving average to 35%. Tactical signals tend to be given when this measure dips below 20%, like at the April 10th near-term low when only 14% of stocks were above this smoothing."

[caption id="attachment_8369" align="aligncenter" width="490" caption="Brown Brothers Harriman"][/caption]

"Note that 200-day participation is moderating in an extended condition near 67%. Typically, readings between 40%-50% have marked “bull market correction” lows. On an intermediate-term basis, we therefore may need to see additional downside in this metric before stocks can move sustainably higher. Both participation readings correspond with our belief that any near-term strength should be part of an ongoing period of consolidation. –A.Wald

It's hard to pick bottoms during market corrections. We sometimes use Fibonacci retracements and prior resistance to find potential support. I think that Ari does a nice job calculating the right measures above longer-term smoothing mechanisms to come up with levels to buy stocks. It makes sense to think that more individual names still need to correct before the overall market can set up for another leg higher.

Source:

Brown Brothers Harriman Equity Strategy May 9, 2011 Ari Wald