Standard Error Channel on Russell 2000 ETF Shows How Oversold It Was
October seemed to suggest that investors shifted to a more risk-averse mindset. The Nasdaq Composite and the Russell 2000 are considered to be riskier than the S&P 500 and both took much bigger losses than the S&P 500 did during October.
The Russell lost 10.91% in October and the Nasdaq lost 9.2%. For the Russell, October’s loss was the worst monthly loss since September 2011. The Nasdaq’s loss was its worst since November 2008.
The Russell also lost ground in September and that put the index in oversold territory based on a couple of indicators. Using the iShares Russell 2000 ETF (NYSE: IWM) as a barometer for the index, we can see just how oversold the Russell was. The chart below shows that the 10-week RSI and the weekly stochastics both hit their lowest levels since early 2016.
You can see that the RSI hit oversold territory for the first time since February ’16 and so did the stochastic readings. Both indicators registered slightly lower readings two weeks ago than they did in 2016.
While these indicators suggest that a bounce is due, there is another type of chart that really shows just how oversold things seemingly got two weeks ago. The chart below shows the standard error channel for the IWM over the last four years. The center line is a regression line and the outer lines are one standard error from the regression line.
As you can see, the IWM was trending higher from that early 2016 low and it was doing so in a very tight range around its regression line. The recent six-week selloff took the IWM below the lower standard error line. This was happening as the oscillators were reaching their lowest readings in almost four years.
If you are an investor who believes that stocks and markets will eventually revert to a mean, the standard error chart suggests that a rally by the IWM is due -- or at least that it is more probable than further losses.
Then again, there is also that old saying that “oversold can always become more oversold.”
