The Wrong Rallies: 4 Overbought Stocks for Traders
When a stock moves higher, should you buy it?
We generally believe that traders should be buying stocks on weakness, so a stock moving higher, in our opinion is either a stock that traders should be taking profits from or a stock that traders should be watching pass them by.
It may sound cruel-or even clueless-but our research into stock price behavior in the short term tells us the same thing over and over again. The key to success as a short term stock trader over years and years of trading in a variety of market environments is to buy weakness and sell strength over and over again.
This is worth keeping in mind particularly when weak markets begin to move higher. By “weak markets” I’m talking about stocks that are trading below their 200-day moving averages. While it is true that many stocks that are trading below their 200-day moving averages will eventually make it above those levels, it is also true that many, if not most, stocks that fall below the 200-day will experience rallies that fail before they finally put together the rally that brings the stock above the 200-day moving average.
What is the proper trader response to this?
In our opinion, traders do themselves well by being skeptical of all stock rallies that take place below the 200-day moving average. Traders may be able to get away with buying rallies below the 200-day moving average when the broader market itself is healthy and trading above the 200-day moving average. But when the broader markets are under pressure, the risks against stocks that are also under pressure grow, making these stocks poor choices for candidates to the long side.
We have incorporated this idea, which is the product of reviewing millions of short term stock trades between 1995 and 2007, into our TradingMarkets Stock Indicators. Here we provide traders with a total of 16 different technical conditions – 8 bullish and 8 bearish – which our research has suggested provide excellent clues to markets that are overextended to the upside or downside.
I have selected one of those indicators to use as a screen for the stocks in today’s report. Here, I looked simply for stocks that have 2-period Relative Strength Index (RSI) values of 98 or more. Our research into the 2-period RSI tells us that when stocks that are trading below the 200-day moving average achieve 2-period RSI values of 98 or more, the stocks are very vulnerable to reversal and a potential resumption of their previously bearish trend. The 2-period RSI is one of the most important short term technical indicators available to traders and we make it a part of every stock analysis we conduct.
All four stocks in today’s report not only have 2-period RSI values of more than 98. These stocks also have Short Term PowerRatings of 1. Based on our research, stocks with Short Term PowerRatings of 1 have underperformed the average stock by a margin of nearly 5 to 1 over the next five days.
Combining these rock-bottom Short Term PowerRatings with the overbought levels seen in the RSIs of these stocks, we have a set of stocks that are very dangerous for traders to continue buying, but potentially lucrative for traders looking to bet against the overbought bounce.
Angiodynamics Inc.
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PowerRating). RSI(2): 74.33
Getty Realty Holdings
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PowerRating). RSI(2): 98.41
IPCS Inc.
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PowerRating). RSI(2): 98.89
Stereotaxis Inc.
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PowerRating). RSI(2): 99.12
Does your stock trading need a tune-up? Read our special, Free Report, “5 Secrets to Short Term Stock Trading Success” for a refresher course on not just why to buy low and sell high, but specifically how you can use intraday weakness in the market to do so. Click here to get your copy of “5 Secrets to Short Term Stock Trading Success” or call us today at 888-484-8220.
David Penn is Senior Editor for TradingMarkets.com.