The Technicals Setting Up For Potential Flush Out

Inside Stocklabs we have mean reversion algorithms that measures greed and fear across all asset classes and stocks and measures the returns of them after achieving extreme levels. We are presently OVERSOLD on the 12 month algorithms; but the data is mixed.

First I want you to see the level of the OS at 1.56. The oversold levels change with markets. For example, during a bad bear market, the OS will be deep, as low as 0.9; but during great bull runs it could be shallow, above 1.6.

If you look back to 2022, during the down 32% year for markets, the OS was at 1.35.

Here is the backtest data for this signal over 5 years. Although the returns are all positive, you can clearly see it starts to pick up in earnest after the 5th trading day.

This dreary technical pattern screams danger and because of that, caution should be exercised. By that I mean raising some cash, hedging via puts or inverse ETFs, waiting it out until some green candles appear.

Yes markets ultimately trade higher and yes this rout isn’t rooted in anything substantial; but it is happening and the seasonality of it happening is worthy of note.

For example: the $SMH is already down 11.7% for September. How does that compare to previous bad Septembers? Lucky for you, I have the data.

Note that all of the other years when the $SMH lost double digits it was in bear market years: 2022, 2008, 2000, 2001, 2002.

Clearly, this sell off is extreme in the context of historical declines and we all know the semis were very overvalued. But overvalued or not, these sort of declines are normally not sustainable lest paired with bad news. Well, where is that bad news? My sense is, this squall will end soon and markets will jump sharply, so try to stay in the game and manage your risk until we get the turn.