The oversold market is at one of those junctures where investors are certainly scratching their heads. The market is oversold; this is pretty clear. But is it a buying opportunity or will all this selling lead to more selling?

Headlines like this one in Saturday's New York Times certainly don't shed any light on the subject:

Figure 1. Headline

Yes, stocks were off for the week, but I don't know if last week's market action constitutes a "plunge" - especially after the two year run up we have had. The tone of the head line is one of fear and that there must be more selling to come. After all, why would there be selling in the first place? Certainly, the headline could have been written as "Stocks Plunge -Time to Buy".

The markets did take a good hit last week. One of my proprietary oscillators that attempts to measure the price action dropped rather significantly as well. There is no point showing this indicator or even explaining it not because its proprietary but because it functions no differently than the garden variety oscillators (i.e., RSI, stochastics) that most chartists utilize. But one thing that I do with my "stuff" is try to quantify what these drops in the indicator mean for prices going forward.

Figure 2 is a weekly chart of the S&P Depository Receipts (symbol: SPY). The red dots are key pivot points, which are the best areas of support and resistance. The yellow dots are those times when my proprietary indicator drops significantly as it did last week. Now a common thing to do is to define a bull or a bear market by where price is relative to it 200 day (or 40 week) moving average or the direction (i.e., up or down) of that moving average. I don't use these metrics, and I define bull and bear markets by how price relates to past key pivot points, but we will save that for another day.

Figure 2. SPY/ weekly

The point here is this: when my indicator drops significantly like it did last week and the 40 week moving average is rising, significant drops in the indicator are generally good buying opportunities. When the market has already rolled over and when we are in a bear market as defined by the 40 week moving average, plunges in my proprietary indicator lead to more selling. Figure 3, a weekly chart of the SPY, shows this nicely in the bear market from 2000 to 2003.

Figure 3. SPY/ weekly

So I guess you can say that oversold readings in bull markets are good buying opportunities. Oversold readings in bear markets tend to lead to more selling. Nothing new. Where are we now? It would seem highly unlikely that the first oversold reading in 12 months would lead to a continued market sell off. Like anything, it's possible but if past patterns hold true, I would look for the market to make a stand here.