“When things are really out of the ordinary,” the Mad Money host said, “the technicals won’t work.”
That’s because technical indicators – put/call ratios, new high/new low ratios, the overbought/underbought oscillator, etc. – require normal market conditions to function properly. They can work so well, in fact, that they predict stocks’ direction with an uncanny consistency. At the same time, extreme highs and lows can make them all but useless.
Take the overbought/underbought oscillator, for instance. This measures whether stocks have moved too far, too fast in one direction as a result of more buying and selling than the market could handle. A minus five on the oscillator indicates extreme selling, and it’s a sign that the market’s ready to bounce. During the declines of 2008-2009, though, investors who trusted the oscillator lost money as stocks continued to head lower and lower and the oscillator dropped to minus 10. The same thing happened when the market rebounded, and the oscillator reached plus seven. Some investors expected a pullback that never came, and they ended up missing a big move.
All of the other technical indicators are much the same. Their ability to describe stocks’ normal movements is of limited use during the height of bull and bear markets. Keep this in mind if the indexes shift significantly in either direction.
“In extremely bullish and bearish markets, these technical touchstones lose their predictive power,” Cramer said, “and too much reliance on them will bring you to an ignominious defeat.”
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