Too Far Too Fast: 5 Overbought Stocks for Traders

Strong markets bring out the "breakout buyer" in most traders. But for those who know that strong markets tend to lift stocks both good and bad, rallies are often as good an opportunity--or better--to bet against stocks as they are an opportunity to bid their still higher..

Every trader fantasizes about being one of the few to short the market at its top in October 1987, or at the peak of the dot.com bubble in 2000, or maybe even as recently as the autumn top last year in 2007.

But as everyone knows, a steady diet of fantasy can be hazardous to the health of a short term stock trader's portfolio. While there are a number of techniques traders can use to sell tops in markets--some of those techniques were even pioneered by TradingMarkets co-founder Larry Connors--we believe there are far more effective, to say nothing of safer, ways for traders who want to bet against stocks to do so.

What are those ways? First of all, we never look to sell a stock short that is trading above its 200-day moving average. Sure, there are plenty of stocks that move lower--sometimes dramatically so--while still trading above their 200-day moving averages. But we have found, through a review of millions and millions of simulated stock trades from 1995 to 2007, that there is simply no significant edge over time in trying to bet against stocks that are above their 200-day moving averages. Over time, this kind of attempt to wager against what are effectively the "strong stocks," will lead to subpar results.

So rather than bet against strong stocks, we prefer to target the weak stocks. Which stocks are the weak ones? We consider any stock that is trading below its 200-day moving average to be a weak stock. Again, this is research-driven. We learned that stocks that are below their 200-day moving averages are particularly susceptible to moving lower--and all the more so after experiencing the sort of temporary strength or bounce that accompanies all significant downtrends.

This temporary strength or bounce is what alerts us that a weak stock, a stock trading under its 200-day moving average, may be vulnerable and a good short selling candidate. We created 16 different indicators--8 bullish indicators and 8 bearish indicators--that help us determine when a stock is either overbought or oversold. These indicators rely on a number of different technical factors to assess whether a stock has moved too low--or too high--in too short a period of time. One of our favorites is the 2-period Relative Strength Index (RSI).

Click here to read more information about our research on the 2-period Relative Strength Index.

Using our 2-period RSI, which we believe is the best technical indicator for short term stock traders, we look for stocks that are trading below their 200-day moving averages and have 2-period RSI values of 90 or greater. This signifies the stock as overbought. We are especially interested in stocks that have 2-period RSIs of 98 or greater. These stocks represent some of the most overbought stocks in the market and are the group of stocks traders looking to sell stocks short should focus on.

The stocks in today's report are charter members of that group of stocks trading below their 200-day moving averages and registering extremely high 2-period RSI values. Additionally, all five stocks in today's report have Short Term PowerRatings of 1, our lowest possible PowerRating score. Our research into short term stock price behavior revealed that 1-rated stocks actually tended to underperform the average stock by a margin of nearly 5 to 1 within five days. This helps make these stocks ideal candidates for traders looking to sell strength in today's booming trading session.

Career Education (CECO | Quote | Chart | News | PowerRating) Short Term PowerRatings 1. RSI(2): 98.95

Centene (CNC | Quote | Chart | News | PowerRating) Short Term PowerRatings 1. RSI(2): 99.94

IKON Office Solutions (IKN | Quote | Chart | News | PowerRating) Short Term PowerRatings 1. RSI(2): 98.39

Obagi Medical Products (OMPI | Quote | Chart | News | PowerRating) Short Term PowerRatings 1. RSI(2): 99.16

Smith & Wesson (SWHC | Quote | Chart | News | PowerRating). Short Term PowerRating 1. RSI(2): 99.68

From PowerRatings upgrades to PowerRatings charts, TradingMarkets has both the analysis and proprietary tools and data to help make you the best trader you can be. Find out what TradingMarkets can do for you and your trading through a free, 7-day trial to TradingMarkets.com. Click here to start your free trial or call us at 888-484-8220.

David Penn is Senior Editor at TradingMarkets.com.