The stock market is now showing signs of weakness that can no longer be ignored. ETFs tracking major market indexes include a few potential buys and two that should be avoided if the goal is to buy a short-term pullback in a long-term uptrend.
The table below shows several index ETFs. Because iShares Russell 2000 Index ETF (NYSE: IWM) and SPDR S&P MidCap 400 ETF (NYSE: MDY) have fallen below their 200-day moving average (MA) these ETFs are not considered potential buys under many strategies even when they are oversold. That includes the RSI25 strategy which uses the 4-period RSI. This table illustrates that in the current market environment, it is important to check all entry criteria when reviewing potential trades.
We have demonstrated the importance of trading with strength for many years. How Markets Really Work is a book that we first published in 2004. Based on data, we determined that the direction of the long-term trend was important to short-term traders.
For the broad stock market, we use the S&P 500 to determine the direction of the long-term trend and SPDR S&P 500 ETF (NYSE: SPY) remains above its 200-day MA. That means stocks in short-term pullbacks remain potential buys as does SPY, SPDR Dow Jones Industrial Average ETF (NYSE: DIA) and PowerShares QQQ (NASDAQ: QQQ).
How Markets Really Work also included general rules for a trading strategy. We updated the book in 2012 and presented test results for the years that followed the original publication of the rules. This strategy provided an average annual return of 10.48% from 2001 through 2011 and showed a small gain in 2008 when the S&P 500 fell more than 38%. In the full test period, the S&P 500 gained an average of 0.04% a year.
The system’s rules are:
- Buy only when the S&P 500 is above its 200-day moving average (MA).
- The stock must also close above its 200-day MA.
- The stock must be down at least two days in a row.
- The 2-period RSI must be below 15.
- The 100-day historical volatility (HV) must be below 35.
More than three hundred stocks meet all of those requirements. We narrowed the list by adding a requirement that ConnorsRSI be below 5 indicating the stock is deeply oversold. The table below shows fifteen stocks that meet the stricter requirements. These stocks are also all experiencing extended losing streaks. Because stocks are mean reverting in the short term, the longer a short-term trend persists, the more likely it is to end. Two of these stocks are on 9-day losing streaks and should be considered potential buys.
Now let’s look at the most overbought and oversold stocks (according to ConnorsRSI) heading into trading for October 13, 2014. ConnorsRSI is a proprietary and quantified momentum oscillator developed by Connors Research that indicates the level to which a security is overbought (high values) or oversold (low values).
CZR (Caesars Entertainment Corporation) is the most oversold stock for the second day in a row with a ConnorsRSI reading of 0.14.
YMLP (Yorkville High Income MLP ETF) is the most oversold non-leveraged ETF with a ConnorsRSI reading of 0.25.
GASL (Direxion Nat Gas Bull 3X) is the most oversold leveraged ETF with a ConnorsRSI reading of 3.23.
HCN (Health Care REIT) is the most overbought stock with a ConnorsRSI reading of 98.48.
TFI (SPDR Muni Bond Barclays Capital) is the most overbought ETF with a ConnorsRSI reading of 98.02.
TradingMarkets Lists provide users pre-populated lists of stocks and ETFs identifying symbols with overbought and oversold ConnorsRSI and Bollinger Bands® readings. The Screener Lists are powered by The TradingMarkets Screener.
All data is as of the end of day on 10/10/2014.