Enjoy the Rally But We Will Revisit the Stock Market Lows

We have had a very volatile three day period, and it does look like we have put in a bottom after a classic, stock market capitulation.

1. Thursday, October 9, 2008: S&P 500 opens at 988.42, and falls to 909.92 for a loss of almost 8%, a major drop.
   
2. After market, Thursday, October 9, Before Market on Friday, October 10: Great fear, and the sky seemed to be falling.
   
3. Friday, October 10: Market opens with a gap down from the previous close and opens at 902.31. Market falls intraday to a low of 839.80 (loss of almost 7%) but recovers and closes at 899.22.
   
4. Monday, October 13: Market finishes capitulation as there is a massive rally, opening at 912.75 and closing at 1003.35, for a gain of almost 10%
   

Expect Rally for now But We Will Re-Test Stock Market Lows



We had been in extreme oversold conditions and we appear to have had a classic stock market capitulation.

We can expect the rally to continue for a while. We speculate that the rally range may reach resistance at 1077 (previous 61.8% retracement from 2002-2003 Bear Market low of 768 to top of 1576) to around 1200 or so (near other resistance).



The S&P 500 around the 1265 area is also the resistance level set during 2003.

If we look at the longer term six year view, we notice that there is a lot of congestion from 2003 to 2006. With the S&P currently at around 1003, this means that most people who bought stocks after 2003 are under water. With the recent stock market capitulation, many individuals and hedge funds and institutional investors have sold much of their stocks and may choose to unload those that they failed to unload around this resistance area.

Re-Test The Lows

Stock market bottoms do not often occur in a V shaped bottom. We expect the S&P 500 to test the S&P low of around 839. We will not know whether this bottom will hold, or whether we will start a new lower trading range.

But with the S&P Bear Market Low from the Great Dot Com Bubble at 768 (2002 to 2003), maybe the market might eventually re-test those lows too?

Let us wait and see what happens at each support or resistance level.

Today's S&P 500 Chart

Overbought, Oversold, and Oscillators

Overbought and Oversold

Many pundits out there throw out the words overbought, and oversold when it comes to stocks or the major stock indices. Is there a way to keep track of overbought and oversold?

Oscillators

There are many technical indicators (special indicators by looking at the stock charts) to help determine oversold and overbought conditions. Oscillators are the most popular. At one point, a stock (or index) is overbought, and then at another point, it oscillates back to oversold.

S&P Oscillator

One popular Oscillator is the S&P (Standard and Poors) Oscillator, which is a proprietary Oscillator. In Jim Cramer's 'Real Money: Sane Investing in an Insane World', Jim Cramer mentions the proprietary S&P Oscillator as one way to spot a market bottom. He says that it costs around $1000 to subscribe.

On Jim Cramer's site TheStreet.com, Jim Cramer Says:

"When the oscillator is over five, people must sell, regardless of how great it looks," Cramer recommended. "There have been some [times] where the animal spirits of the market have been so great that it's gone to plus nine and 10, but the percentages on the upside are that there's going to be a selloff. It may not be major, but I do believe it will happen."

When it's over five, if he were fully invested, Cramer said he would cut to being 75% invested. At this time, short-term traders should maybe go 50% invested, and "if you're a guy who is able to short, maybe 25% short," he said. "That's how much I have faith in this indicator. I have faith in almost no indicators other than this one.

"Helene Meisler, [a contributor to RealMoney.com does] her own oscillator work," Cramer said. "She seems to agree with me on the site. When we both agree, we tend to have a pretty powerful correlation between right and wrong."

RSI Oscillator

For more inexpensive ways to determine oversold/overbought, one can use the RSI indicator. RSI stands for Relative Strength Index. When the RSI is over 70, the stock or index is overbought. When the RSI is under 30, the stock or index is oversold.

Of course, stocks or indices can remain oversold or overbought for long periods of times:



In the above example with Garmin (Chart of GRMN with RSI information here), we notice that when RSI is in overbought territory, GRMN is near its high, and when RSI is in oversold territory, GRMN is near its low.

Towards the middle of 2007, we do notice that GRMN remains in overbought territory, but GRMN makes very good gains during this time. This is an example of an overbought situation remaining overbought for long periods of time. The same can happen with oversold stocks or indices. Some technicians suggest to wait till the RSI goes down below 70 after remaining overbought, or wait for RSI to go up above 30 after remaining oversold.

Other Oscillators

There are many other oscillators as well such as using Bollinger Bands, or Stochastics. TradingDay has a good link to some of these oscillator methods.

Bottom Indicators

There are many other bottom indicators as well. Some oscillators above may be more suitable for traders and short term traders. But if one wants to find more long term investable bottoms, you can use some of these other methods:

1. S&P 500 Stocks Above the 50 and 200 Day Moving Average (Low value = Bottom)
   
2. S&P 500 High-Low Index (Low Value = Bottom)
   
3. 10 Day Moving Average of Put-Call Ratio (High value = bottom)
   
4. Ratio of Stocks Above 200 Day Moving Average to Stocks Above 50 Day Moving Average
   
5. Bull-Bear Ratio and Bullish Percentage
   
6. Index in Relation to 52 Week High and 52 Week Low
   

You would like to look at several of the different indicators and look at the support and resistance levels of a particular stock or index.