TradingMarkets Danger Zone: 3 Overbought Stocks for Traders
Stocks were flat to slightly lower in the first 90 minutes of trading on Wednesday, as the markets worked to digest the massive gains from yesterday.
Yesterday’s buying brought both the S&P 500 and Dow industrials into overbought status. Although neither market is at extreme levels of being overbought, the fact that both markets have 2-period RSIs of more than 79 means that traders are more likely to find quality pullbacks in the coming days than at present.
The other option, of course, is for traders to look at the most vulnerable stocks, those stocks that are not only overbought, but are also trading below their 200-day moving averages. We have found that the combination of being overbought and trading below the 200-day moving average to be a good starting point for traders looking to find weak stocks that are experiencing temporary bounces.
Coventry Health Care Inc.
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PowerRating) Short Term PowerRating 1. RSI(2): 99.67
However there are additional edges that swing traders can take advantage of when looking to sell weak stocks short. One of the edges we have uncovered is what we call the 5+ Consecutive Up Days rule. This rule, which is one of our TradingMarkets Stock Indicators, points out that stocks that are trading below their 200-day moving average and have experienced five or more consecutive up days have produced negative returns one week later.
An example of a stock with five or more consecutive up days that is also trading below its 200-day moving average would be Coventry Health Care.
Pantry Inc.
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PowerRating) Short Term PowerRating 1. RSI(2): 95.06
In addition to consecutive up days, we found that stocks trading below their 200-day moving averages also responded similarly to consecutive higher highs. In fact, we found that, if anything, overbought stocks were even more sensitive to consecutive higher highs. Our research indicated that stocks that had experienced 5 or more consecutive higher highs actually produced negative returns in one-day, two-day and one-week timeframes.
An example of a stock that has experienced five or more consecutive higher highs is Pantry Inc.
Our last stock in today’s report has experienced both 5 or more consecutive up days and 5 or more consecutive higher highs. This stock, Teletech Holdings, Inc., is arguably the most overbought of the bunch, not just because of its string of consecutive up days and higher highs below the 200-day moving average, but also because the stock has a 2-period RSI of more than 99. Our research indicates that stocks with 2-period RSIs of more than 98 — that are also trading below their 200-day moving averages — have produced negative returns one day and one week later.
Teletech Holdings Inc.
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PowerRating) Short Term PowerRating 1. RSI(2): 99.16
Note that all three stocks in today’s report have Short Term PowerRatings of 1. Our research into short term stock price behavior indicates that stocks with Short Term PowerRatings of 1 have underperformed the average stock by a margin of nearly 5 to 1 after five days.
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David Penn is Senior Editor at TradingMarkets.com.