Heading into Monday’s open, SeaDrill Limited (NYSE: SDRL) is a short trade candidate based on a trading strategy that showed a compound annual growth rate of 60.6% in back testing. Shorting is often considered a high risk strategy that can lead to large losses. Shorting can also be a quantified strategy that leads to profits in a variety of market conditions. The difference is in how the short trade candidates are selected.
Some traders will decide they should short a stock after it becomes overvalued based on its fundamentals. This is the type of trade that can lead to large losses because as the economist John Maynard Keynes is supposed to have said, “markets can remain irrational longer than you can remain solvent.” An irrational market can push prices much higher than the fundamentals justify and traders who are short can suffer losses when that happens despite the fact that they are probably right about the stock’s fundamental.
Rather than basing a short trade on beliefs about fundamental values, traders can use a quantified strategy. For example, the CRASH trading strategy was developed to take advantage of certain inherent aspects of trading stocks.
- The first is that stocks consistently become overbought.
- The second is that extremely overbought stocks tend to drop fast. In fact, they drop faster than oversold stocks rise.
- The third is that overbought stocks, especially higher volatility overbought stocks tend to attract “fast money” which tends to over‐price these stocks as momentum buyers push prices higher while short‐sellers scramble to cover as these prices rise.
This combination causes these stocks to become susceptible to rapid short‐term reversals. CRASH was created to take advantage of these high probability reversals.
In back testing, CRASH showed a profit in all years from 2001 through 2012. The system has continued to perform well since these results were first published.
CRASH uses ConnorsRSI as a starting point to identify stocks to short. Well-defined rules provide traders with a short trade strategy that works extraordinarily well in bear markets and maintains profitability even during bull markets.
A strategy based on CRASH is one of the tools included in a suite of strategies TradingMarkets.com is now offering. This package includes more than 100 quantified trading strategies that can be used to trade your own account or to operate a professional trading business. These strategies include short ideas in addition to CRASH as well as long trading strategies.
To learn more about this suite of strategies, click here.
Now let’s look at the most overbought and oversold stocks (according to ConnorsRSI) heading into trading for September 22, 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).
CLW (Clearwater Paper Corp) is the most oversold stock with a ConnorsRSI reading of 1.08.
SIVR (ETFS Physical Silver) is the most oversold non-leveraged ETF with a ConnorsRSI reading of 5.75.
NUGT (Direxion Gold Miners Bull 3X) is the most oversold leveraged ETF with a ConnorsRSI reading of 8.53.
COL (Rockwell Collins) is the most overbought stock with a ConnorsRSI reading of 98.44.
DUST (Direxion Gold Miners Bear 3X) is the most overbought ETF with a ConnorsRSI reading of 91.71.
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 9/19/2014.