At a market top, we tend to see a number of stocks and ETFs overbought on PowerRatings. This is simply because stocks and ETFs tend to move in the same direction and in a rally most stocks will show gains. When a large number of stocks are overbought, the rally seems to run out of energy and a high number of overbought stocks and ETFs is often a sign that the market is about to reverse. Despite the gains in major market averages seen over the past several days, PowerRatings indicates ETFs tracking major stock market indexes are in neutral.
There is only one sector ETF, SPDR S&P Homebuilders ETF (NYSE: XHB) that has become overbought.
The tables above were created with the My PowerRatings Portfolio feature at the PowerRatings web site. Traders can use that feature to set up any view of the market they find useful.
Until more stocks become overbought, traders should be prepared for the rally to continue. Even in a strong up move, some stocks remain oversold. PowerRatings points to Hydrogenics Corporation (NYSE: HYGS) and Ducommun (NYSE: DCO) as potential buys. Both stocks have PowerRatings of 9 heading into Thursday’s trading.
PowerRatings are based on the relationship between price and the 5-day moving average (MA) of price. The further prices move away from the 5-day MA, the stronger the tendency to snap back becomes. PowerRatings uses the 5-day MA and several other components to identify high probability trade entry points. This strategy was thoroughly back tested and the history of over 4 million trades was analyzed.
We know from back testing that PowerRatings can be used as the basis of a trading strategy. Detailed back testing has confirmed that the higher the rating, the greater the one week historical gain has been for stocks and ETFs with that rating. For best results, enter trades on stocks with a PowerRatings of 8 or higher with a limit order 3-7% below the previous day’s closing price. Higher % limit entries have historically shown a greater percentage of winning trades but higher % limit orders also reduce the chance of trade execution.
As an example of a trading strategy that can be used, in the past, buying stocks with a rating of 9, on a 3% pullback the next day and selling after the stock closes above its 5-day simple moving average has been profitable 75% of the time with an average gain of 4.3%. Other entries and exits also show high winning percentages and large average gains.
All data is as of the end of day on 8/20/2014.