In my previous article A Standard Rally from Trading Tutors Newsletter Issue #303, we discussed the current rally in terms of the largest previous rally during this bear market. In this article we are going to look at the lows made over the past 12 months in comparison to significant lows in history.
Now of course in terms of point movement, the market has fallen more than it ever has before. As we’ve discussed previously however, this is hardly a valuable measure considering the Dow went into the 1929 crash at less than 10% of even its current value today.
In percentage terms the 1929 crash was nothing short of massive. The Dow Jones lost 89.5% over 3 years. Chart 1 uses what is known as a logarithmic scale which makes percentage movements equal in size on the chart. This really puts 1929 in perspective to other bear markets, including the current one. We can also see this current episode is significant, being greater than 1974, 1987 and 2001 in percentage terms.
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Again, let’s now take a slightly different tact and compare these moves by another relative measure. Last time we looked at using the Bollinger Bands to see how far a market has moved away from its average. This time we are going to use the Relative Strength Index or RSI to perform similar analysis.
What the RSI allows us to do is establish how much a market has gained versus how much it has lost over a given period. To keep things consistent with our Bollinger Bands method, I have also used a 50 day period for the RSI.
Looking back through the chart at key periods like the ones highlighted in Chart 1, we can build a picture on the current market episode. Chart 2 shows the RSI levels for 1929, 1974, 1987 and 2001 and allows us to see how things compare.
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By this measure, 1987 rates as the largest relative change and this is no doubt due to the steepness of the 1987 crash. 2001 and 1929 rate fairly equally and 1974 is the closest to the current RSI low in October 2008. On this last point, it is interesting to note that in all of the four periods compared, the RSI hit its lowest reading at the low, rather than before it as is currently the case.
So what does this tell us? In my view it shows that while significant, the market has – at least by some measures – been more oversold in the past than in this move to date. Although there is a divergence in between RSI and price at the March 2008 low, the question remains as to whether the market has been oversold enough?