I hate the terms ‘overbought’ and ‘oversold.’ At best, they cause confusion, and at worst they serve as the basis for faulty decision-making among armchair market technicians. So let’s talk about them. What do they even mean? And can they be of any use to us?
Most of the MBS Live members who’ve been interested enough in technical analysis over the years to discuss RSI (the “relative strength index,” a technical indicator chiefly responsible for the proliferation of overbought/sold jargon) the site have been of the mind that the terms mean that MBS or Treasuries are ripe for a correction in the other direction. In other words, they might say “bonds are oversold! We have to bounce back soon!”
Sadly, that’s not how it works. Disappointingly enough, overbought/sold statuses are like so many other technical indicators in that they simply provide lines in the sand that help us measure what’s happening. In and of themselves, they don’t make any prediction as to which side of the line we’ll be on.
Treasuries are currently oversold (see the chart below). But that doesn’t mean a big bounce back is imminent. If that was the case, all the many instances of ‘overbought’ (in teal in the chart) would have meant a big bounce was coming, but alas… 2014 remained mostly drama-free and reasonably resilient.
What it does mean is that we now have a line in the sand to let us know when the tide might be turning. As soon as the RSI comes back below ‘oversold’ status, we can start hoping for some follow through in a more positive direction.
Of course, technicals can always be rendered completely meaningless by data and events. In that regard, next week’s FOMC announcement continues to be the biggest focal point in the near term. Today’s biggest data is certainly Retail Sales at 8:30am, but it would be no surprise to see prevailing momentum and tradeflow considerations trump the data once again.