I mentioned a couple of nights ago that we had a good shot of bouncing within the week and I’m starting to see more signs pointing to that happening. Sentiment is starting to get ultra bearish and the markets continue to act like caca (technical term). As regular readers know, I monitor Wordens version of the McClellan Oscillator (T2106) as one of my sentiment tools along with their “Stocks trading above their 40 day ma” (T2108). Both are starting to read extreme levels as the markets push lower.

The McClellan is typically oversold under readings of -200. As the chart shows, it can and does push lower, but readings under -300 are not common and it is currently pushing towards -400. This is typically associated with a snap back rally within days.

T2108 (Stocks above 40 day ma) is currently at 18.94%. I’ve used 20% in T2108 as a level to watch for an oversold market. T2108 is a slower indicator, but it does a pretty good job of warning you that things are starting to hit extremes on intermediate terms. Look at how long it stayed overbought earlier this year before the markets hit some turbulence. It did provide some clues by turning lower ahead of the indices as well.

So what can we do with this information. First, just because the markets are oversold, that doesn’t mean they can’t get more oversold. One should never trade solely on indicators. However, with conditions ripe for a snap back, traders should be on alert for possible scenarios such an exhaustion gap down, or a situation where the markets refuse to drop despite a negative catalyst. These could be signs that the market is ready to snap back.

Second, even if the markets have a violent rally squeezing shorts, it doesn’t mean a bottom would be in. In most situations where the markets pullback to these extremes, there is usually a retest and possible break of support. A snap back is just that, a temporary relief due to oversold conditions. Use it as an opportunity to lighten up if you feel trapped in any positions, or trade it aggressively using intraday signals. Don’t take it as an all clear to lever up on margin.

Maybe the $FB IPO will act as a catalyst, or maybe it will take some more Greece or $JPM news to flush out the last bulls, but something will occur in the next few days to trigger some sort of relief from the selling .
Good Trading,
Joey