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click here for a free trial. First, let's summarize the bullish argument: Typically, going from a big oversold reading to a big overbought reading in a very short period of time is considered bullish. At the least, it means that the market will rarely go from being extremely oversold to extremely overbought and then come immediately back down to oversold again. Instead, it tends to oscillate around that overbought level, making several attempts at rallying and at making higher highs. More often than not, we end up with a market that takes the averages to a higher high while the oscillator doesn't make it to a higher high, eventually giving us a negative divergence. If we go back to the October low, you can see we went from an extreme oversold reading to an extreme overbought reading in a matter of 10 days. In that same time frame, the S&P 500 went from 775 to 900. For the next three months, the oscillator barely got below that zero line -- and the S&P stayed in a trading range as well.
- We're oversold. The put/call ratio is once again on the rise, as it was in May. Since this correction began, volume has been lighter than it was. The three major averages are still holding fast to their respective support levels: 9000 for the Dow Industrial Average, 975 for the S&P 500 and 1600 for the Nasdaq.
If you squint, you'll see the very small negative divergence that took place in January. On Jan. 6, the S&P closed at 926 (point A). On Jan. 14, the S&P closed at 931 (point B). Now, note those two points on the oscillator chart, and you can see the oscillator failed to make a higher high on Jan. 14 while the S&P made a higher high. That is a negative divergence. But that's also three months after the oscillator made that initial rush higher. Now let's take a look at the current situation. We've gone from extremely overbought to extremely oversold. We couldn't expect the market to reverse course immediately back in October (from up to down) after that initial rise, so we can't expect it to reverse course now after this initial decline. Look how much more work the market did in the three months after that initial rise. Shouldn't we now expect the market to do more work on the downside after its initial fall? So if you're bullish (and I'm not bullish now, but I do expect an oversold rally sometime this week) and are wondering what it will take for the oscillator to once again establish itself in an oversold position that's offering more than a short-term rally, then you need to take a closer look at how long we milled around before falling in that October-to-January time period. However, if you prefer, you can use the January-to-March period as well. From that initial peak oversold reading in late January, it took the market until mid-March to make its low (S&P at 800). During that time, the oscillator made two higher lows while the S&P tested that 800 level. That was about two months. So time is a factor here, and the oscillator tells us the time is not ripe for more than an oversold rally.