Short-Term, High-Probability Mean-Reversion Indicator: China, Gold and Oil Have Hit Short-Term Oversold Extreme

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Includes: DIA, EEM, EFA, EWY, EWZ, FXI, GDX, GLD, IBB, IWM, IYR, OIH, QLD, QQQ, RTH, SDS, SMH, SPY, SSO, TBT, TNA, TZA, USO, VXX, XLB, XLE, XLF, XLI, XLU, XLV, XLY
by: Andrew Crowder

Monday, I mentioned the possibility of entering into a DIA position but the trade was contingent on how the Dow (NYSEARCA:DIA) opened the trading day. DIA opened lower which pushed the RSI (2) significantly lower so the DIA trade was immediately off the table. However, the continued collapse in China (NYSEARCA:FXI) , Gold (GDX and GLD) and more importantly, USO, brought about some interesting set-ups as the trading day progressed.

Towards the end of the day, USO had hit a short-term (1-3 days) “very oversold” extreme with an astonishingly low RSI (2) of 0.5. Typically, when readings hit this type of low, a short-term bounce occurs. As a result of the low short-term readings, I decided to take a position in USO towards the end of the day.

You can check out the trade here. (Collective2 has yet to fix the drawdown issue from 1/14 which is a bit frustrating. The drawdown (which is a software glitch in their reporting) should be fixed soon. Hopefully, it will be within the next few days.)

Anyway, today should be quite interesting as the Fed meets and comes out with their rate decision. While a hike is most likely not in the cards, more transparency is expected, so it could be a wild ride once the report comes out.

As I mentioned before, Gold has taken a tumble as of late and as a result GDX and GLD have pushed into “very oversold” territory. Over the past year, gold has performed extremely well surrounding the Fed meetings. So much so that the days surrounding the FOMC meetings gold has been higher from the day before the announcement to the day after 6 out of the last 7 times. Five of those occurrences saw gains in excess of 1%.

Given the recent oversold nature of the precious metal, I would expect to see a short-term bounce over the next day or two. I will be keeping a close eye on GLD and GDX to see if they both push lower over the next few days. If they do, then I would anticipate another trade in the High-Probability, Mean-Reversion strategies.

Short-Term High-Probability, Mean-Reversion Indicator – as of close 1/25/10

Benchmark ETFs

* S&P 500 (NYSEARCA:SPY) – 67.7 (neutral)
* Dow Jones (DIA) 87.1 (very overbought)
*Russell 2000 (NYSEARCA:IWM) – 38.0 (neutral)
* NASDAQ 100 (QQQQ) – 57.6 (neutral)

Sector ETFs

*Biotech (NASDAQ:IBB) – 48.6 (neutral)
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Consumer Discretionary (NYSEARCA:XLY) – 65.1 (neutral)
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Health Care (NYSEARCA:XLV) – 52.3 (neutral)
* Financial (NYSEARCA:XLF) – 50.4 (neutral)
* Energy (NYSEARCA:XLE) – 55.7 (neutral)
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Gold Miners (NYSEARCA:GDX) – 16.1 (very oversold) / RSI (2) – 4.4

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Industrial (NYSEARCA:XLI) – 69.5 (neutral)
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Materials (NYSEARCA:XLB) – 42.7 (neutral)
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Real Estate (NYSEARCA:IYR) – 76.2 (overbought)

* Retail (NYSEARCA:RTH) – 68.1 (neutral)
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Semiconductor (NYSEARCA:SMH) – 61.6 (neutral)
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United States Oil Fund (NYSEARCA:USO) – 13.1 (very oversold) / RSI (2) – 0.5
* Utilities (NYSEARCA:XLU) – 74.7 (overbought)

International ETFs

* Brazil (NYSEARCA:EWZ) – 36.6 (neutral)
* China 25 (FXI) – 21.7 (very oversold) / RSI (2) – 2.2
* EAFE (NYSEARCA:EFA) – 65.8 (neutral)
* South Korea (NYSEARCA:EWY) – 44.1 (neutral)

Commodity ETFs

* Gold (NYSEARCA:GLD) – 18.7 (very oversold) / RSI (2) – 4.4

Ultra Extremes

* Small Cap Bear 3x (NYSEARCA:TZA) – 60.1 (neutral)
* Small-Cap Bull 3x (NYSEARCA:TNA) – 36.8 (neutral)
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UltraLong QQQQ (NYSEARCA:QLD) – 56.7 (neutral)
* Ultra Long S&P 500 (NYSEARCA:SSO) – 66.5 (neutral)
* Ultra Short S&P 500 (NYSEARCA:SDS) – 32.4 (neutral)
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UltraShort 20+ Treasury (NYSEARCA:TBT) – 38.1 (neutral)

Disclosure: I am long USO.