Revision:
7 May 2008 - Added in AUSGROUP chart for example purposes.
Trying to squeeze more thing out from my brain before I go temporary offline. Moving average can be used to determine oversold condition.
Most of market technicians including myself use overbought/oversold indicator such as Relative Strength Indicator (RSI), Rate of Change (ROC) etc to determine oversold condition for entry. Every high level indicator has their strength and weakness.
High level indicator:Just for an example, RSI. RSI uses number of days close up and down in its calculation. What if the price keep going down slowly? If the counter move down day by day, the RSI will go down as well but why this counter isn't really oversold even RSI is below 30%?
My interpretation of high level indicator is those indicators that uses some variables in a formula to calculate end results. The higher level indicators have more complicated the formula
RSI flag is being formed. Weak holders keep cutting loss and the volume keep exchanging hand (refer to the above mentioned example of trader A sells to trader B, trader B sells to trader C). Weak holders are still remains in this counter staying between hope and fear. This is the reason why the selling isn't over.
Venture from last year to present. Take note how many oversold has this counter has triggered by RSI (indicated by black arrow). Divergence (1) Price vs RSI and (2) Price vs Vol occurs around Nov - Dec 2007.
SinoTechFibre triggers some RSI oversold but failed to rebound. The price keep going south ignoring all RSI signal. Imagine you bought since the first RSI signal. How many times you need to cut loss?
7 May: Added in AUSGROUP which is a recent case study. AUSGROUP has successful rebound from oversold even though there is fundamental changes. Of course, always plan cut loss price before enter.---
After showing how did RSI failed us (RSI sometimes does give us good signal. Do not abandon it.), do you still think you can use the blackbox over and over again? I remembered few months ago a lot of forumers mentioned that we can't use TA anymore during this period. I would say partial yes/no because most of the TA indicator they are using is high level indicator (blackbox) and these indicators often fail during bearish market.
Side note:Using MA to find oversold condition (at least for short and medium term) can be interesting.
Avoid volatile market that is derived by news.
What is oversold?
Until a certain point when the selling become drastic (the price deviates 20% below MA(10)) weak holders are shaken off bit by bit. Imagine you are a retailers and your losses are 20% over 10 days of holding this counter. What will you do? Will you cut loss? Yes, it is crazy and 20% loss is really something when the market is so bearish. This is the point when retailers exit and where funds (or smart money) start to buy in.
Note:The price will starts to stablize after the smart money bought into this counter because they have to support this counter from going south (to protect their interest). However, unfortunately some of the smart money are not holding for long term so distribution can happens after the price being pushes up for some time. You have to know this.
Make sure no fundamental change during this drastic drop.
Another thing to understand is every counter has their set of rule because the 'players' within this counter have some characteristic different from other counters, for example contra players, swing players, long term investors etc.
