The S&P 500 just flashed a 'buy' signal that could mean an oversold rally is on the horizon, Fairlead Strategies' Katie Stockton says

• The S&P 500 just flashed a technical "buy" signal, according to Katie Stockton of Fairlead Strategies.
• The positive move in the S&P 500's MACD indicator suggests an oversold rally could materialize.
• "This reflects significant improvement in short-term momentum despite the day-to-day volatility that we have been suffering through."

The S&P 500 could be on the verge of an oversold rally following a technical "buy" signal, according to Katie Stockton of Fairlead Strategies.

The buy signal, which is based on the moving average convergence divergence indicator, or MACD, represents the first buy signal since mid-March for the S&P 500, and ends the "sell" signal that flashed in early April. Both of those prior signals worked well for short-term traders, with the S&P 500 jumping as much as 8% after the mid-March buy signal, and the S&P 500 falling as much as 13% since the April sell signal.

The MACD is a trend-following momentum indicator that technical analysts use to show the relationship between two moving averages of a security's price. A signal line is plotted, which can function as a buy and sell signal. Stockton uses MACD to capture momentum and trend across multiple timeframes. The indicator appeals to her because it's very black and white, generating either a buy, or a sell.

Combined with a recent DeMARK counter trend signal, Stockton said the recent MACD buy signal could drive an oversold rally in the S&P 500 to 4,200, which represents potential upside of about 6% from current levels.

But the recent buy signal isn't an all clear for traders to jump back into stocks, according to Stockton. Nor is there a clear signal for investors to use an oversold bounce as an opportunity to start shorting stocks. "Our review of the constituents of the S&P 500 yielded few high-conviction setups, long or short," Stockton said.

Essentially, stocks are in a no-mans land environment as a lot of technical damage has been done where it's hard to go long, but stocks are also down so much that shorting them now might not offer a good entry point for traders.

"We are not keen on adding counter-trend long exposure without additional support discovery, and most stocks are too oversold for us to feel like we have a good entry for short selling," Stockton said.

To get long, traders would at the very least like to see a series of higher lows in the S&P 500, combined with resistance at 4,200 decisively turning into support. But until that happens, heightened volatility in the market is likely to remain.