For the first time in almost a year, the Relative Strength Index (RSI) for the Dow Jones Industrial Average is in oversold territory. The last time it was oversold was in April last year. After coming out of oversold territory at that time, the markets climbed steadily for the next nine months, but the markets have been steadily declining since early February and have fallen below the oversold threshold. Does that mean we should jump into the markets? Not necessarily. Let’s first review what the RSI is.
It is a measurement tool used in technical analysis for those studying stock charts. It is a momentum indicator measuring speed and magnitude of a security to determine if it is overbought or oversold. We won’t explain the mathematical formula for how the daily number is derived (if you are interested you can find that on the internet) but it generates a number between 0 and 100. If it is above 70, it is overbought and if it is below 30, it is considered oversold. At the end of trading on Friday, March 13, the Dow’s RSI was 27.96.
Click this link to see a recent chart of the Dow:
If you look at the chart for the Dow, you will see how it has been steadily declining since early February and so has the RSI. It has fallen below the 30-threshold, but that doesn’t mean you should become automatically bullish on the markets. The markets could remain depressed, and the RSI could remain in oversold territory. The time to seriously consider entering is when the RSI comes out of oversold territory and above the 30-threshold.
The RSI is only one signal. It is not the be all and end all and should be used with other technical signals. One other signal is the stochastic oscillator. It too is in oversold territory. It is only below its oversold threshold for the third time in the last 12 months. Look at how the peaks and valleys of the stochastic oscillator compare to the RSI and to the corresponding value of the Dow as well.
Finally, look at the moving average convergence divergence (MACD). It too is pointing down and is showing no signs of changing. The RSI is a great indicator to determine if it the security is overbought or oversold. If other technical indicators are saying the same thing at the same time, you can make a strong case that a reversal is in order, and you can take advantage of a short-term low. Like the saying goes, buy low.
The market itself is a macro viewpoint if you are looking to enter the market. If you are sitting on the fence deciding whether to buy a stock, look at the Dow itself first. A rising tide raises all ships. Should the Dow rebound, it can bring up all stocks too. With the Dow in oversold, take notice. When it comes out of oversold, be prepared to act.
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