Ask Colin

For the first time in 15 years, the ANZ bank monthly RSI has dipped below 50 (Question sent in February 2008). Although oversold, is it common for stocks to go beyond these oversold indicators before they stabilise?

First, I have to state that what I am saying below is NOT about ANZ as such and is not giving any view about ANZ or what you should do about it. I have to make this caveat to protect myself in that I never respond to queries about specific stocks for fear that I am giving advice. This is because I have chosen to be an educator of investors rather than to be a licensed adviser. Instead, I will comment on the chart you sent in terms of technical analysis theory and it equally applies to any chart.

The issue you are picking up is a common feature of momentum oscillators, of which RSI is one. When we have a strong upward trend, a momentum oscillator will tend to stay in the top half of the oscillator scale. This is clearer on RSI than on some other momentum oscillators, because RSI has a fixed scale between zero and 100, where other oscillators have unlimited scales. You can see this has happened for a long period on the monthly RSI chart of ANZ, which you sent to me. When there is a lengthy downward trend, the opposite happens. The RSI will tend to stay in the lower half of the scale for a prolonged period.

This is perfectly normal for a momentum oscillator and confirms the consistency and durability of the trend. The ANZ monthly RSI has, as you say, now fallen into the lower half of the scale. This in itself does not mean we should now expect a downward trend. That is only one possibility and we will need to wait to see what unfolds. However, it does tell us that the market for ANZ has become more volatile than it has been and you need to consider what that may mean for your strategy for ANZ. 

All of that said, this normal momentum oscillator behaviour in a trend can be useful in finding good entry points. Usually, analysts simply adjust the RSI oversold level to 40 instead of 30 in a persistent upward trend. Likewise, the RSI overbought level is adjusted from 70 to 60 in a persistent downward trend that we may wish to short. You seem to have used a quite long period for your RSI and in the great upward trend there were no oversold readings even at 40 on the RSI scale. For the method of finding entries to work, it may be necessary to use a shorter period for the monthly RSI. On the ANZ monthly RSI chart which you sent to me, a dip below 50 would have been more appropriate in hindsight than 40.