Up Big, Overbought and in the Red: Bearish Bets for Traders
Feeling the need to fade the rally that began in late November, now beginning its eighth day? If you think now is the right time, then make sure you place your bets against the right stocks.
Our research continues to remind us that there is an edge in the short-term from buying weakness and selling strength. On the long side, this tends to mean looking for stocks that are oversold, or stocks that have fallen for days, creating lower lows.
We are not looking to catch falling knives here, however. Instead we are looking for weakness-in-strength. By this I mean stocks that are in a generally bullish mode, stocks that are for example trading above their 200-day moving average, but are experiencing temporary weakness for one reason or another. We look to buy these stocks that are experiencing atypical weakness with an eye toward selling them as they revert to the mean and resume their bullish ways.
The same thing in reverse applies to selling or shorting stocks. Here, we look for strength in a context of weakness. This means stocks that are in a generally bearish mode, stocks that are trading below their 200-day moving average, but are benefiting from atypical strength
— perhaps from short-covering, perhaps from the strong winds of a rising stock market at their backs.
These are the stocks to “sell on strength” whether as a profit-taker or a short-seller.
How do we measure strength-in-weakness? I have already pointed out one simple way to determine weakness: is the stock trading above or below its 200-day moving average? If below, then we can consider it a weak stock.
There are a number of ways of measuring strength. One, most directly, is simply to look at price action. Has the stock made a series of consecutive up days, or a set of five or more consecutive higher highs? Is the stock registering as “overbought” in a major technical indicator such as the RSI (Relative Strength Index)?
Two stocks, stocks I uncovered by way of our TradingMarkets Stock Indicators page, fall into this category of strength-in-weakness. Because there is an abundance of stocks that have fallen into this category due to the recent strength in the broader market, I looked for stocks that were exhibiting more than one type of strength-in-weakness.
Specifically, I looked for stocks with 2-period RSI values above 98, indicating exceptionally overbought conditions, as well as stocks that were up five or more consecutive days. Again, both of those conditions had to be taking place while the stock was trading below its 200-day moving average.
The first stock I spotted was Copa Holdings
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PowerRating). Copa Holdings is a member of the Transporation industry and has a PowerRatings (for Traders) rating of 2. Copa Holdings may be a classic case of strength-in-weakness. The stock peaked out in July just shy of $74 per share and fell to as low as $30.25 late in November. Over the past few days while the market rallied, CPA rallied as well, climbing to $39.25 in the first few days of December. In addition to having been up six of the past seven sessions
— including five in a row — the stock is increasingly overbought due to its above-98 RSI values.
The other stock I want to point out is U.S. Cellular
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PowerRating). U.S. Cellular, as the name suggests, is a member of the Telecommunications industry, and has earned a PowerRatings (for Traders) rating of 2. Shares of USM fell below their 200-day moving average in the first half of November, as the stock fell from a closing high of $104.23 in early September to a closing low of $75.57 in late November.
Increasingly overbought according to its 2-day RSI, U.S. Cellular has been up seven of the past eight sessions as the stock moves toward the $85 level, where the stock’s 200-day moving average awaits as potential resistance.
David Penn is Senior Editor at TradingMarkets.com