Bear market rally on the works?

October 13th, 2008

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Back in What is the meaning of ?oversold?? Part 1: Technical analysis perspective, we explained that

In technical analysis, there is a class of indicators called the ?momentum indicators.? Examples of this indicator include stochastic, Relative Strength Index (RSI) and so on. Basically, these indicators measure the momentum of price movements. If the momentum is far too much on the upside, then it can be said that the prices are ?overbought.? Conversely, if the momentum is far too much on the downside, then they are ?oversold.?

The theory behind momentum indicators is that at the either extremes (i.e. oversold or overbought), it is a matter of time before exhaustion sets in and cause prices to reverse. In that sense, these indicators are contrarian in nature because it tells the technical analyst to sell when prices are overbought and buy when they are oversold.

One month has passed and the selling momentum had intensified and brought prices even lower. Many technical analysis indicators have now approached extreme bearish levels.

At such extreme levels, it is very possible that we will see a counter-trend rally soon. But please note two things:

  1. It does not mean that prices cannot go down further in the short-term. Who knows, perhaps there will be more panic selling in the days to come, thus bringing the technical indicators into even more extreme levels?
  2. In all likelihood, such a counter-trend rally will still exist in the context of a bear market.

In the infamous Great Depression bear market from 1929 to 1932, stock prices did not fall straight down. As we explained in Second lesson of ?29 crash?bear rebound,

Back in 1929, the bear market rally lasted for around 6 months from November 1929 before resuming a downward trend.

You may want to take a look at the stock charts from 1929 to 1933:

Source: Financial Armageddon

Notice that many of the bear market rallies last more than a month, the longest being 6 months.

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