5 Overbought Stocks for Traders: EXEL, JTX, LSCC, USU, UTIW

Like an athlete collapsing in an exhausted heap after a tough workout, stocks have sagged somewhat since their massive Tuesday rally. This has left a number of stocks wearily overextended to the upside and more than vulnerable to being picked off by short sellers.

These are not stocks that are in generally strong shape, trading above their 200-day moving averages, for example. Rather these are stocks that have been moving higher in recent days but, essentially, have no real reason to.

These are stocks that are trading below their 200-day moving averages who were able to get a boost from the bullishness earlier in the week. But as this broad-based bullishness wanes and stocks are forced to rally on their own merits, weak stocks such as the five overbought stocks in this report are likely to find their rallies short-lived.

I have already hinted at why these five stocks are considered weak stocks: they are all trading below their 200-day moving averages. But how do I know that they are overbought? More to the point, how do I know they are so overbought that betting against them makes sense?

We use an indicator that most traders are very familiar with, the Relative Strength Index, to determine when stocks are overbought - or oversold for that matter. This is a popular and widely used technical indicator. But we have made two key modifications to the RSI, modification we believe make the indicator far more effective for traders working in the short term time horizon of five to eight days.

The first modification was to shorten our swing, as they say in baseball. The traditional RSI relies on 14-periods as its "look back" time frame. We found that this was far too long for short term traders and, instead, have found a 2-period RSI to be far more effective in spotting the sort of changes in the indicator that matter most to short term traders.

The second modification was to raise the bar for overbought and oversold conditions. Typically, the RSI considers a market to be overbought when its RSI rises above 70 and oversold when the RSI falls below 30. We found this to be far too generous, to put it bluntly, allowing just about any old stock to be seen as overbought or oversold. We found that by making it harder for stocks to be considered overbought or oversold, we were able to find stocks that truly had moved into extreme territory. For us, an RSI above 98 is considered overbought and an RSI below 2 is considered oversold. Quite a difference from the traditional RSI.

To read more about how you can use the 2-period RSI in your short-term stock trading, click here.

All of the stocks in today's report have Short Term PowerRatings of 1. This puts all four in that category of stocks that our research says are likely to underperform the average stock by a significant margin. Specifically, we found that 1-rated stocks actually underperformed the average stock by nearly 5 to 1.

In addition to the PowerRatings charts provided below, I have listed the 2-period Relative Strength Index values for each stock. As you can see, all of these stocks also have 2-period RSIs of 98 or greater.

Exelixis Inc. (EXEL | Quote | Chart | News | PowerRating). RSI(2): 99.91

Jackson Hewitt (JTX | Quote | Chart | News | PowerRating). RSI(2): 98.92

Lattice Semiconductor (LSCC | Quote | Chart | News | PowerRating). RSI(2): 98.67

Usec Inc. (USU | Quote | Chart | News | PowerRating). RSI(2): 99.40

UTI Worldwide Inc. (UTIW | Quote | Chart | News | PowerRating). RSI(2): 99.10

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David Penn is Senior Editor for TradingMarkets.