Mean Reversion Trading and How to Use PowerRatings Under the 200-Day

One of the things that I’m sure a lot of people wonder when they see our Top 25 PowerRatings List on some days is this:

“So many of these stocks are trading below their 200-day moving averages. What good are high Short Term PowerRatings then if we’re not supposed to buy stocks below the 200-day?”

It is true that we believe that one of the easiest ways for traders to stay out of trouble is to avoid buying stocks that are trading below their 200-day moving averages. This is one of the most basic edges that short term traders who trade stocks and trade ETFs can include in their trading in order to improve their results.

Take a look at some of the stocks that have been hardest hit over the past year. A lot of pain would have been avoided simply by staying away from stocks once they slipped under their 200-day moving averages.

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But that doesn’t mean that traders can’t use our Short Term PowerRatings with stocks that are trading below the 200-day moving average. One way that I have not talked about much is especially for those traders who are selling short stocks or ETFs that are trading under the 200-day.

Every trader wants to know when to say when, or – in the words of “The Gambler” – when to walk away and when to run. For short term traders selling stocks short, when you see your stock’s or ETF’s Short Term PowerRating climb up into the 8 or higher range, it is likely time to lock in gains on the short side.

BAC Chart

Consider the stock of Bank of America
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BAC |
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, currently making headlines due to the ouster of John Thain, former CEO of Merrill Lynch. A short term trader who turned against this stock, selling it short when BAC’s Short Term PowerRating was downgraded to a 2, could have used the stock’s major Short Term PowerRating upgrade to 8 as a signal that BAC was increasingly oversold and vulnerable to reversal to the upside. This would be an excellent time to cover that short.

Because high Short Term PowerRatings stocks tend to outperform the average stock in the short term, these are not stocks you want to sell short. At the same time, they are not the best stocks to buy, either, because they are under the 200-day moving average.

But if you are trading a stock to the short side and you see its Short Term PowerRating climb above 7, think about taking profits. A bounce in the stock may happen sooner than you think.

Find out what mean reversion trading can do to boost the performance of your short term trading in 2009. Click here to start your free, 7-day trial to our Short Term PowerRatings today!

David Penn is Editor in Chief at TradingMarkets.com.