Overbought/Oversold: Two Risky Words

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Overbought/Oversold: Two Risky Words

The short-term overbought/oversold indicator, which is avidly followed by some public investors, is a 10-day moving average of advances and declines in the market. Caution: Sometimes in the beginning of a new bull market the index will become substantially overbought because it has just come out of a long decline. This should not be taken as a sign to sell stocks. A similar occurrence can happen in the early stage or first leg of a major bear market when the index becomes unusually oversold. This event is really telling you that an eminent bear market may be beginning.

I once hired a well-respected professional who relied on such technical indicators. During the 1969 market break, at the very point when everything told me the market was beginning to get into serious trouble and I was aggressively trying to get several portfolio managers to liquidate stocks and raise large amounts of cash, he was telling them that it was too late to sell because his overbought/oversold indicator said the
market was already very oversold.

You guessed it, the market split wide open after the index was oversold and really started to decline.Needless to say, I rarely pay attention to overbought/oversold indicators.

What you learn from years of trying experience is generally more important than the opinions and theories of experts using their favorite indicator. Sometimes, the more widely quoted and accepted the market or economic expert, the more trouble you might, on occasion, get yourself into.

Who can forget the expert who in the spring and summer of 1982 insisted that government borrowing was going to crowd out the private sector and interest rates and inflation would soar back to new highs? The exact opposite happened; inflation broke and interest rates came crashing down. Conventional wisdom is rarely right in the market.