Stocks ended lower last week and have declined for the past two weeks in a row. For now, traders should continue to view market weakness as a buying opportunity in a long-term uptrend. The 200-day moving average (MA) can be used to define the direction of the trend. SPDR S&P 500 (NYSE: SPY), for example, is about 7% above its 200-day MA. The chart below shows that SPY is now oversold according to PowerRatings and could be a buy if it opens lower on Monday morning.
Pullbacks in an uptrend can be defined in a number of ways. Our recent research explains how MAs can be used to identify market pullbacks. Trading Stocks & Options with Moving Averages; A Quantified Approach provides step-by-step instructions on how MAs can be used to find stocks that are oversold in the short-term and due for a bounce.
With one of the strategies detailed in the book, a buy setup signal is given when the 5-day MA drops significantly below the 10-day average while the price remains above the 200-day MA. This indicates the stock is pulling back in the short-term while in a long-term uptrend.
To increase the probability of a winning trade, we can require that additional buy setup conditions are met. For Monday’s trading, we found four stocks will start trading with both the quantified MA strategy setup completed and a PowerRatings of 8 or higher.
PowerRatings are based on the relative strength or weakness of particular stocks or ETFs. The higher the rating, the greater the one week historical gain has been for stocks and ETFs with that rating. For best results, enter these trades 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.
In the past, buying stocks with a rating of 8 on a 3% pullback the next day and selling five days later has been profitable 71% of the time. The average winner has gained 3.1%. Other entries and exits also show high winning percentages and large average gains.
Stocks meeting the Quantified MA and PowerRatings criteria are listed below:
BBVA Banco Franc
Each of these stocks is trading above its 200-day MA, the 5-day MA has fallen below the 10-day, and the PowerRatings is 8 or higher. They should be considered buy candidates if they continue to pullback on Monday.
All data is as of the end of day on 12/13/2013.