Four Oversold Stocks for Traders
Famous Chinese communist leader Mao Zedong famously said that it is always darkest before it goes completely black. And it is that kind of thinking that not only probably helped us win the Cold War, but also keeps us one step ahead of those who allow their emotions to believe that things that are going badly can only get worse.
Context is key. When some stocks become oversold, with significantly more traders looking to sell compared to those eager to buy, those stocks are often headed lower. These are stocks that have broken down, that are trading below their 200-day moving average and that are better left alone–or sold short–than bought on a bet. For these stocks, while “completely black” would probably be an exaggeration, it would also be a mistake to make a habit of buying these broken down names.
On the other hand, for some stocks, it is often darkest right before they turn around and start heading toward the light. These are stocks that are in good shape, that have been performing well for investors, but are experiencing temporary weakness, or a temporary disappointment. At the end of the day, this temporary weakness or disappointment is a pain in the neck to deal with for these companies. But it does not represent a fundamental challenge to the company’s ability to continue to outperform.
These stocks, when they become “oversold” are the stocks traders should be looking for. Rather than trying to buy strength and then hope to sell even greater strength, the TradingMarkets approach to trading focuses on buying weakness and then selling strength.
Other trading approaches essentially bet that a talented weekend jogger will one day be able to win the Boston Marathon. This is the philosophy of “buying high and selling higher.” We prefer to wager that that someone who is generally healthy and comes down with a cold or the flu will sooner than later be feeling better and back on his or her feet. This approach to trading is also called mean reversion trading and is a mainstay of what we teach traders every day. (Click here to join our Path to Professional Trading course).
In this spirit, I used the TradingMarkets Stock Indicators to see if I could find some of those otherwise-healthy stocks that have called in sick recently.
One of my favorite indicators to find these quality oversold stocks is the Relative Strength Index. Larry Connors’ version of the RSI is a 2-period RSI, which is much more conducive to short-term trading that the traditional, 14-period version introduced by market technician Welles Wilder decades ago. Connors shows us that stocks that become oversold according to the RSI, reaching a low RSI level below 2, have actually been higher in one-day, two-day and one-week timeframes. These stocks dramatically outperformed those “strong” stocks with RSI levels that were much higher.
Click here to read Larry Connors and Ashton Dorkins’ article on the RSI.
This morning the RSI screen gave me nine candidates. So in order to narrow the field down, I looked to see if any of these candidates appeared on any other bullish stock screens. I found four that appeared on another favorite screen: 5 or more consecutive down days.
This screen is also somewhat counterintuitive. Traders never feel more bullish about a stock than when it is moving higher day after day after day. Unfortunately for these traders, our research shows that the longer this sort of abnormal behavior continues, the more likely the stock is to reverse.
On the contrary, when stocks have fallen for day after day, and traders are moving from disappointment to despondency about them, we have found that it is often the best time to buy, especially for short-term trades.
Combining the RSI screen with the consecutive lower lows screen is what helped me narrow the original list of 13 stocks down to four. All four of these stocks have PowerRatings of at least 8, and should be under consideration for traders looking to exploit the “fear, uncertainty and doubt” that cause good stocks to become weak.
Donaldson Company
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PowerRating) has a PowerRating (for Traders) of 8. The stock soared from near 40 in late November to as high as 48 in the first half of December. A recent sell-off has brought the stock back to the 43-44 level, as the market for Donaldson Company becomes increasingly oversold on a technical basis.
Plexus Corporation
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PowerRating) started the day with an 8 rating but has slipped to a 7 in the first hours of trading. Plexus rallied as high as $35 on an intraday basis in early November, and fell as low as $24 and change in recent trading.
The Shaw Group
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PowerRating) is an 8-rated stock. SGR rallied above $75 in late October and again in early November before breaking down during the fall correction. The stock traded below $55 per share yesterday for the first time since September.
Last but not least, 8-rated Synaptics
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PowerRating) peeked above $60 per share at the beginning and end of November. But it has sold off significantly since then, closing most recently just south of $43. The stock is increasingly oversold, having recently taken out its October lows.
David Penn is Senior Editor at TradingMarkets.com.