Is the JSE overbought in the short term?

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With global equity markets losing steam in the last few days, it is no wonder we are hearing more and more talk about markets being overbought and overvalued in the short term. The FTSE/JSE All Share Index is no exception and we have seen the Index pull back by 2,1% since its high of 29 565 on 15 April 2010.

An important measure of a market’s short-term overbought or oversold status is to look at the trading range of an index around its 50-day moving average. The moving average of a stock market index or share price is the arithmetic average of the prices over a certain moving time frame, for example for a 50-day period from 8 February to 21 April and again from 9 February to 22 April, etc. A moving average smooths out the daily price fluctuations and helps us to see the emerging trend.

The accompanying graph shows how the FTSE/JSE All Share Index (black line) has been trading above and below its 50-day moving average (grey line) over the past fifteen months. It can be seen that the All Share Index (ALSI) has been trading above its 50-day moving average for most of the time since mid-March 2009, i.e. just after the market made a low and began its recovery. After crossing above the 50-day moving average in early in March, it only dipped below very briefly three times during the rest of 2009.

The graph also shows the ALSI’s trading ranges, with the shaded yellow area representing one standard deviation from the moving average (the market’s normal trading range) and the red and blue shaded areas representing between one and two standard deviations. When the Index moves into (or even below) the blue area it is a good indication of a short-term oversold position and when it moves into the red area (or above) it indicates a short-term overbought position.

The market’s recent pull-back of 9,0% from mid-January to early February 2010 saw the ALSI decline below its 50-day moving average substantially (it even dipped below the blue area), but the market resumed its upward trend and the ALSI went back above its moving average towards the end of February. It is also interesting to note that during the time the Index went below the 50-day moving average, the average barely reversed its upward slope, which shows the short-term trend in the market remained positive.

So where are we now? The market’s pull-back over the past few days has resulted in the ALSI easing back into its normal trading range (the yellow area). It is therefore no longer in extremely overbought territory.

The graph can also be a great indicator of market momentum. If the trading bands move wider it shows momentum in a direction and when the bands contract its shows there is a large probability of a turnaround in the short-term trend. There has been a slight narrowing in the trading bands of the ALSI over the past few days, and if this continues we could see a further downside in the short term. It should, however, be noted that this graph is of a short-term nature and the position can change very quickly.

Source: Plexus Asset Management (based on data from I-Net Bridge)

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