10 Lessons Learned in the Selloff

You'd be stunned at how people are ove-reliant on a single element in their trading. It's no wonder they were blindsided this month.

3) Oversold Markets Can Become More Oversold

Suddenly, everyone has become a technician. Everyone on TV -- including fundamentally oriented mutual fund managers -- are telling us that the markets are oversold. Thanks for nothing.

My answer to these budding technicians is "So what!" Just because a market is "oversold" is not a guarantee it ain't heading even lower. My advice to these TV pundits: Do not use words you cannot adequately define.

For the record, when something is overbought or oversold, all we are observing is that it is at an extreme oscillation measure within its historical range.

Apparently, it is a big secret that overbought markets can keep right on rallying, and oversold markets can head even further south. Even when items are two or three "standard deviations" away from trend, that does not guarantee an immediate reversion to mean. Think of "oversold" as a statistical analysis based on probabilities.

Recall the standard bell curve. As markets move toward the outer ends, they become overbought or sold. But there is always more room in each direction, however rare those situations may be.

Unusual market events are by definition outside the mean, i.e., more severe than normal distribution patterns. Hence, they can always get more overbought or sold.

4) Support & Resistance Don't Always Hold

A surprising number of technicians seem to have forgotten this basic element of TA. Support lines -- and trend lines for that matter -- are ephemeral. They are not etched in steel-reinforced concrete, but rather are wisps of sentiment. When the psychology shifts, formerly solid support can disappear quickly.

This is important to understand if you are going to play in the dangerous surf, i.e., catch the falling knife during selloffs.