Overbought Begets More Overbought: Swing Trading the Extremes
Stocks made little progress on the eve of the Presidential election on Tuesday. The Dow industrials and S&P 500 ended Monday down a little, the Nasdaq Composite up a little.
Where we are on Tuesday resembles very much where we were on Monday. Stocks are increasingly overbought. Sunday night, I saw that there were more than 200 stocks with our worst Short Term PowerRating of 1. Stocks with Short Term PowerRatings of 1 are those that were most likely to underperform in the short term based on our historic testing.
Monday night, that number had climbed above 300.
As I have written, sooner or later stocks will become overbought and stay that way until we are looking back on a bull market bottom. I’ve suggested a few ways that this might happen in previous columns.
But until that moment comes along — however inevitable it may be — our job as swing traders is to buy weakness, not to fear it, and to sell strength, rather than chase it.
This approach to trading requires picking the right targets, of course: the stocks with the high Short Term PowerRatings after they have pulled back, the stocks with the low Short Term PowerRatings after they have bounced into overbought extremes. But when those right targets are our focus, then not only are we more likely to see the market the correct way, we are also more likely to trade the market the right way: with sentiment perfectly misdirected and the historical edges thoroughly on our side.
No new stocks or ETFs for today. Over the past few days, I’ve given out a number of high Short Term PowerRating inverse and leveraged inverse ETFs. Those looking to take advantage of the potential breakdown from currently overbought conditions should look among these exchange-traded funds for worthwhile funds to watch.
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