March 5, 2007

In this week's free newsletter, we'll take a look at gauging  Oversold Conditions.

Winds of Change

The market has finally turned a corner it appears, and we've gotten a major pullback for the first time in many months.  The steady uptrend which had lulled traders to sleep with incremental gains month after month has suddenly turned into a nasty downdraft with a significant lack of buyers so far.

Technical analysts have a vast array of tools at their disposal to determine overbought and oversold conditions, and while they do help to confirm certain opinions at times, they cannot be relied upon for precise timing of entries and exits in times of heightened emotions.

This is indeed a time of heightened emotions, which comes as no surprise given the big change of character this market has undergone in just the past week.  When market indexes go into freefall mode and the volatility jumps, traders aren't always logical with decisions and instead many are prone to panic.  Such emotions are the driving force in market shifts like we're seeing, which means indicators play less of a part (as do support and resistance levels which were previously respected).

Pulling Back, But How Far?

Newbies to technical analysis start to learn about various indicators, along with what it means to be overbought or oversold.  Technical Analysis 101 might say that a stochastic reading below 20 can be considered oversold, but it is important to realize that oversold conditions can stay in place indefinitely.  Just because an indicator suggests the conditions are ripe for a bounce certainly does not mean that you're facing a high-probability buying opportunity.

Here's a look at the NAZ chart as it appears tonight, and you can see that the stochastic reading is in "oversold" territory.  However, support zones have been broken and there's no reason to start getting long until there is sufficient proof that anything but a quick bounce is imminent.

TCNet chart courtesy of Worden Brothers, Inc.

Don't Bank on a Lasting Bounce Yet

It's important to keep in mind that last week's shakeup has spooked some bulls, and that's going to play a big part in how well and exactly when this market can recover.

There are plenty of trapped longs out there who put cash to work out of concern that the market might keep rallying without them, only to find that their timing was poor and they now hold losing positions after this correction.  That same group of traders are now looking for exits, and virtually any higher prices will entice them to raise cash so that they can safely head to the sidelines.

We'll see a decent relief rally come at some point, but a long-lasting bounce is not likely to be right around the corner.  The bulls who will be selling into strength will keep the upside rather contained, so if you're looking for bargains in longer-term accounts, sit tight because we may yet see lower prices in the coming weeks while this corrective phase plays out.

Here at TheStockBandit.com, we have been sitting in cash since first thing last Tuesday morning.  This week we have so far only flipped a couple of day trades as we keep timeframes short and let this pullback play out.  Don't be in a hurry to bargain hunt here!  Stay nimble and wait for the market to come to you.

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