Markets can sometimes rally when oversold due to several factors and dynamics in the financial markets. It's important to understand that market behavior is complex and influenced by various factors, and not all oversold conditions lead to rallies. However, here are some reasons why the stock market might be ready for a bounce from current levels.
Short Covering:
When a market becomes oversold, there are many more sellers than buyers, causing prices to drop significantly. Traders who have sold short (betting on a price decline) may start to buy back shares to cover their positions, which can create upward pressure on prices as demand increases.
Source: Barchart
Reviewing a SPY (S&P 500 Index) chart, the daily chart illustrates a downtrend. Not shown, the weekly is in a downtrend, and the monthly is still up. Is the daily and weekly chart just a minor downtrend in the more significant timeframe uptrend?
The daily relative strength indicator (RSI) shows the market trades in a technical over-sold area below the 30-line. The recent oversold reading at the beginning of October 2023 shows a technical oversold bounce. This prompts me to believe the upcoming seasonal buy will be more of a bounce than a significant trend change. More on the seasonal pattern later. The SPY is also approaching the 50% retracement of the recent rally from October 2022 to July 2023, where some bargain-hunting buying may appear.
Short-Term Trading Strategies:
Intraday or short-term traders may use oversold conditions to make quick profits. These traders might buy when they see oversold conditions and sell when the market rebounds, amplifying short-term rallies.
Positive News or Catalysts:
Even in an oversold market, releasing positive news or a catalyst is not uncommon. The Federal Reserve Board (FED) will meet this week and is expected to leave rates unchanged. But, if they signal a shift to pausing rate hikes, this could be bullish for stocks. Another event to watch this week is Apple's earnings report. Apple carries a significant weight in the S&P 500. The end of the week will conclude with last month's employment situation. The FED has been trying to slow employment, and if the report shows a slowing job growth, we could see some positive reaction in market prices. Such news can change sentiment and investor perception for a market bounce.
Some large investors are in the news with comments like this, "Stocks will start to recover when the market believes that bond yields have peaked," said Sam Stovall, chief investment strategist at CFRA Research.
Lower interest rates certainly would assist corporations and individuals in managing their debt while seeing their equity appreciate as stock prices rise.
A Seasonal Pattern That Screams "Look At Me!"
The following seasonal pattern has a track record that is difficult to ignore, regardless of the "it's different this time" crowd mentality. While I'm following this trade for a potential trade setup, my plan calls for the trend to be in the direction of the seasonal pattern. The market is in a downtrend, and I will need that to change to take this trade. Some traders may be willing to buy as prices fall; that is fine if your plan calls for that trading style.
Source: Moore Research Center, Inc. (MRCI)
Through extensive research, MRCI has found that the S&P 500 index has closed higher on or around December 02 than on October 26, 15 of the last 15 years, two of those years never had a daily closing drawdown.
Jerry Toepke, MRCI Editor, commented, "Although there have been a few sharp drawdowns, the index has been higher on about December 1 in not only each of the last 15 years but also 24 of the last 26."
While the historical seasonal patterns reflect near-perfect results, traders are reminded that these results are not guaranteed to continue. MRCI provides market research, not trading recommendations.
What has been identified by MRCI is a seasonal window that, in the past, prices have risen. With that, a trader would use their strategy and fundamental research to determine if the trade will fit their risk tolerance.
The Fall season for stock indexes usually sees weakness in September, and the market followed that pattern this year. October is known for volatility; the daily volatility index (VIX) has risen from 16.80 to 21.90.
The question remains, "Will this near-perfect seasonal pattern and other scenarios we discussed be strong enough to lift market prices?"
Products to Trade the S&P 500
Traders have multiple products available to participate in this trade if it fits their risk tolerance. The S&P 500 index is the most liquid stock index traded. Equity traders could use multiple exchange-traded funds (ETFs), but the most liquid is the SPY. Futures traders could trade the mini-sized contract (ES) or the micro-sized contract (MES) Barchart (ET.) The options market has a host of available products to trade as well.
On the date of publication, Don Dawson did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
