Using the weekly Overbought/Oversold (OBOS) indicator as a timing tool can help getting more favorable entry points, potentially avoiding losses in the near-term.

For those that track DALI often, you likely noticed that the Technology moved back into first place after passing up Communication Services. Although both sectors are tied with 213 signals, the tiebreaker goes to the sector with the most Xs (aka the most near-term strength), which is the Technology sector in this case. With new technology and AI developments happening almost every other day, it may be tempting to simply pour money into those areas. While our technical attribute and fund scores serve as a strong foundation for identifying what to buy, incorporating the weekly OBOS indicator as a secondary tool can help pinpoint when to buy, by highlighting near-term overbought or oversold conditions and offering valuable insight into a stock’s near-term performance.

The weekly Overbought/Oversold (OBOS) is an indicator that tracks a security’s price in relation to its previous prices, to determine how ‘overbought’ or how ‘oversold’ a specific security is. Broadly speaking, the OBOS is computed by:

1. Taking ten weeks’ worth of price data (50 days)
2. Computing the “trading band” of the security, by using a volatility calculation
3. Determining the location of the current price relative to its “trading band”
4. Expressing the result as a percentage (e.g. -70%/+70%)

As described on our Weekly Overbought/Oversold (OBOS) white paper, securities tend to exhibit a "mean-reversion," meaning that prices often move back toward the middle of their trading band after experiencing strong short-term market fluctuations. When looking at 1000 of the largest US-listed equities over the past 30 years, the chart below details the number of weekly OBOS observations (1.56M to be exact), split up between each of the 6 weekly OBOS buckets (refer to chart to see bucket ranges). When looking at the 1-week and 2-week forward returns on the chart, the concept of mean reversion becomes quite evidence. Periods when a security is oversold tend to show stronger positive returns, while overbought conditions are often followed by slightly negative performances (click here to read more).

To demonstrate this phenomenon using a real example, we can highlight Oracle (ORCL) after its large 35% performance last month. As shown below, ORCL reached a high above $344, before consolidating in price over the next few days. The stock ultimately reached a second sell signal at $272, roughly 20% below its high as it moved towards the midpoint of its 10-week trading band. Oracle reached a weekly OBOS reading <70% on September 17th when the price moved closer to $300, which, had you decided to invest when the OBOS was in more normalized territory, you would have been up slightly after today’s move.

In conclusion, having a clear process for entering a position is essential. With so much happening in the market at any given time, its easy to feel the urge to jump into every opportunity. However, using the weekly Overbought/Oversold (OBOS) indicator as a timing tool can help getting more favorable entry points, potentially avoiding losses in the near-term.