Moving averages (MAs) are usually thought of as a trend-following tool. That traditional thinking fails to take advantage of the moving average’s ability to pinpoint oversold extremes in price. That characteristic of MAs is the concept behind quantified research that was detailed in Trading Stocks & Options with Moving Averages; A Quantified Approach, a guidebook that explains how to use MAs to find stocks that are oversold in the short-term and due for a bounce. This guidebook provides specific rules to identify the best buy candidates and then provides precise sell rules that help maximize short-term gains. Readers can customize the parameters based on their preference for more or less trading activity.
Through research, we found the key to using MAs as short-term trading tool is to study the relationship between the MAs. For example, a stock can become oversold when a short term MA such as the 3-day is significantly below a longer MA like the 20-day.
Among the strategies in the book is one that buys when the shorter-term 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. As shown in the guidebook, testing on a broad list of stocks from January 2001 through the end of September 2013, this strategy has been profitable on 73.5% of its trades, gaining an average of 4.8% with an average holding period of just under four days. That is just one of the variations explained in the guidebook.
Fully quantified test results from January 1, 2001 to September 30, 2013 show that ten of the top performing variations have win rates of more than 70%.
Top 10 Performing Variations Sorted by Win Rate
Heading into Monday’s open, three stocks are potential buys under this strategy.
These stocks are also potential buy under a simple PowerRatings trading strategy.
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 8 on a 5% pullback the next day and selling after the stock closes above its 5-day simple moving average has been profitable 72% of the time with an average gain of 3.9%. Other entries and exits also show high winning percentages and large average gains.
Now let’s look at the most overbought and oversold stocks (according to ConnorsRSI) heading into trading for December 15, 2014. ConnorsRSI is a proprietary and quantified momentum oscillator developed by Connors Research that indicates the level to which a security is overbought (high values) or oversold (low values).
CX (Cemex S.A.B. De C.V. Sponsored) is the most oversold stock with a ConnorsRSI reading of 0.08.
EWW (iShares MSCI Mexico Investable Mkt Idx) is the most oversold non-leveraged ETF with a ConnorsRSI reading of 0.72.
EDC (Direxion Emrg Mkts Bull 3X) is the most oversold leveraged ETF with a ConnorsRSI reading of 3.63.
CISG (Cninsure Inc) is the most overbought stock with a ConnorsRSI reading of 95.24.
SJB (Proshares Short High Yield) is the most overbought ETF with a ConnorsRSI reading of 98.33.
TradingMarkets Lists provide users pre-populated lists of stocks and ETFs identifying symbols with overbought and oversold ConnorsRSI and Bollinger Bands® readings. The Screener Lists are powered by The TradingMarkets Screener.
All data is as of the end of day on 12/12/2014.