Wednesday, August 24, 2011

What is oversold in a bull market?

From a reader:
Can't remember what TA book I read this in, I was wondering your opinion on the RSI. During a strong trend the overbought or oversold levels tend to shift. For example, since the March '09 lows, the +70 level on a daily chart was breached routinely, and on the other hand the 30 handle was respected, even during the flash crash.

With this most recent correction there is a very clear breach of the 30 handle on daily RSI. Obviously the market has the potential to bounce here, but I was wondering your thoughts; is this is a signal the market has changed it's character?
This is covered in more advanced TA books, specifically one by Connie Brown, CMT. In rallies, RSI tends to move between 40 and 80 while in declines it moves between 20 and 60. Of course, there is more to it than that but the point is that oversold in a bull market is not the same as oversold in a bear market. In bull markets' you buy the dips. In bear markets, you have to get more deeply oversold in order to get a tradeable bounce.

So, does a recent sub 30-reading mean the trend has changed? Can't say for sure based on just this but it sure fits.

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