Oversold Stocks for Turnaround Tuesday
With the market holding its gains from last week, a number of weak stocks are managing to sustain their lofty levels. That situation, based on our research into short term stock price behavior, is subject to change.
When markets are moving higher, it is hard to blame traders for looking for stocks to buy. After all, if stocks are “going up,” then shouldn’t it be the goal of every trader to start buying?
This is the product of more than a decade of “buy high, sell higher” trading philosophy at work. It is a purely momentum approach to trading which suggests that strength today means strength tomorrow. Many traders, especially in recent years, have been quite successful with this approach.
But if you ever wondered who those momentum traders were buying their stock from, chances are they were buying it from traders like us who would rather sell strength than buy it.
Our approach to short term trading is really old fashioned. We look to buy low and sell high. Or, when stocks have rallied a great deal in a short period of time, we look to sell high and buy low by selling stocks short.
What stocks do we like to sell short? For one, we would rather pick on a stock that has already shown itself to be weak. Would you rather bet against a team with a great winning record, or a team with multiple-game losing streaks in his recent past?
We believe we have a weak stock when we find a stock trading below its 200-day moving average. These are stocks that our research indicates are more likely to move lower rather than higher over time. As such, more often than not, any show of strength in these stocks is suspect and, when that strength is bold enough, an opportunity for traders to bet against the stock.
We measure the short term strength of a stock with the 2-period RSI. When we have a stock that is weak–trading below the 200-day moving average–and showing short term strength in the 2-period RSI with a reading of 98 or more–then we know we have a stock that is very vulnerable to turnaround and reversal.
So it is a two step process: first we identify the weak stocks. We use the 200-day moving average for that. Then we look for evidence of short term strength. There are a number of tools that traders can use, but in this example, we use the 2-period RSI. When that 2-period RSI climbs above 98, then there is a strong possibility that we have a short sell candidate on our hands.
All four of the stocks in today’s report have 2-period RSIs of 98 or more. This makes them among the most overbought stocks in the market. Combined with the fact that all four are trading below their 200-day moving averages, these overbought stocks are ones that traders should either avoid or consider selling short.
Two of the stocks have Short Term PowerRatings of 2 and two have Short Term PowerRatings of 1. Our research into short term stock price behavior going back to 1995 suggests that stocks with Short Term PowerRatings of 2 or lower are among the stocks most likely to underperform the average stock over the next five days. Stocks with Short Term PowerRatings of 1 have actually underperformed the average stock by a margin of nearly 5 to 1 over that short term time frame.
Nordic American Tanker
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PowerRating). Short Term PowerRating 1. RSI(2):
Venoco
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PowerRating). Short Term PowerRating 1. RSI(2):
Rackable Systems
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PowerRating). Short Term PowerRating 2. RSI(2):
Jabil Circuit
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PowerRating). Short Term PowerRating 2. RSI(2):
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David Penn is Senior Editor at TradingMarkets.com.