Swing Trading: Three Ways of Looking at an Overbought Market
What does it mean when a market has become short-term overbought?
An overbought market is a market that has reached levels from which it has historically underperformed or, often, reversed and headed lower.
For swing traders, the arrival of overbought markets can mean many things. Overbought markets can be opportunities for swing traders to take profits in positions taken during previous pullbacks. Overbought markets also can serve as warnings for swing traders to avoid stocks that may have moved “too far too fast” and are due for underperformance or a pullback.
This is one underrated aspect of knowing when stocks are overbought and oversold. Even if you are not a short term swing trader, understanding when a stock is oversold can make a difference even for the investor looking to buy and invest in quality stocks that the market “has put on sale.”
Of course, the third kind of overbought market is the kind of overbought market that swing traders may consider selling short. The most important feature that makes this overbought market different from the others is that it only includes stocks trading below their 200-day moving average. As Larry Connors writes in Short Term Trading Strategies That Work: A Quantified Guide to Trading Stocks and ETFs:
Most cataclysmic individual stock drops, over the past century, have occurred when the stock was under its 200-day moving average. A stock’s decline may have started above the 200-day MA but in nearly all cases, the majority of its decline occurred after it broke below the 200-day moving average.
You can read more about overbought markets and the 200-day moving average in Larry’s book, Short Term Trading Strategies That Work. If you don’t already have one, be sure to pick up a copy for free at the link below.
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Here are 7 Stocks You Need to Know for Friday
Earnings season continues on the final trading day of the week with a number of blue chip stocks reporting quarterly profits, revenues and guidance going forward.
Among the companies reporting are industrials like ^CAT^ which was up more than 1% on Thursday, closing higher for a third day in a row and nearing overbought territory above the 200-day. Up three in a row and finishing in overbought territory above the 200-day were shares of ^GE^, also reporting on Friday.
Also up for a third day ina row ahead of its quarterly earnings report on Friday were shares of ^MCD^. MCD is again trading near year-to-date highs.
What’s down on an up day? Shares of ^CRM^ continue to pullback above the 200-day, closing lower for a second consecutive session. CRM closed lower by more than 5% ahead of trading on Friday.
^SLB^ rallied to its highest closing levels since the spring ahead of its scheduled earnings announcement on Friday. The stock was up more than 2%, gaining along with fellow oil and gas equipment and services giants ^HAL^ and ^NOV^.
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David Penn is Editor in Chief of TradingMarkets.com