Up, But Under: 2 Bearish Bets for Traders

Here’s a good news/bad news scenario for you: a stock has moved up strongly, 10% or more. That’s the good news.

But for all that movement, the stock is still below its 200-day moving average. That’s the bad news.

And here’s the question: over time, are stocks in this sort of good news/bad news scenario, good buys or good sells?

The answer may surprise you. Our research, looking at millions of trades from 1995 to 2006, has discovered that stocks that climb more than 10%, while still remaining below their 200-day moving averages have shown negative returns one week later. This means that many of these stocks, however powerfully they may rally, are in reality stocks to be avoided, or even shorted.

This research shows how important context can be. Whenever I think of the 200-day moving average, I’m reminded of that Warner Brothers cartoon that showed a picture of the equator as a literal band wrapped around the Earth with the word “Equator” stamped on the ground next to it. If there is only one moving average that you should keep in mind as a trader, then the 200-day moving average is it. The 200-day moving average effectively divides the market into two worlds: one in which, on average, good things tend to happen to stocks, and another in which, on average, bad things tend to happen to stocks.

Trading above the 200-day moving average is an example of the first world. Trading below the 200-day moving average is an example of the second.

Let’s take a look at two stocks that are living in this second world, the world below the 200-day moving average. Both stocks are up at least 10%, but because they are still below the 200-day moving average, traders would be advised to be suspect of their potential for further gains in excess of the 10% they have already achieved.

The first stock is Jack in the Box
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. JBX has a PowerRating (for Traders) of 2, making it the least attractive of all stocks up 10% but still below their 200-day moving averages. Jack in the Box is a leading fast food chain, made popular in recent years by the extensive use of a namesake character, Jack, in the company’s advertising campaign.

There are eight other stocks in the list of stocks up 10% or more but still trading below their 200-day moving averages. All of these eight stocks feature PowerRatings (for Traders) of 3.  In order to narrow these stocks down to one or two, I looked at the other indicators on our TradingMarkets Stock Indicators page. I noted that, of the eight, one stock, an electronics company named Micrel
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, also appeared in another bearish list.

That list was the list of stocks that had “lapped up” 5% or more while still trading below the 200-day moving average. 

Similar in some ways to the “gap up”, a “lap up” occurs when a stock opens above the previous day’s close — but not necessarily above the previous day’s high, which would create a “gap up.”  That difference aside, as Ashton Dorkins and Larry Connors pointed out in an article on gaps and laps in December of last year, the same sort of emotion and news that drive a gap up, also drive lap ups. (Click here to read the article). 

In both cases, gap ups and lap ups, context is key.  If that gap or lap occurs when the stock is trading below the 200-day moving average — just as when a stock climbs by 10% or more while still below the 200-day moving average — then try to resist the urge to pile in. The chances are pretty good that the bounce will be short-lived. And the resistance found at the 200-day moving average — assuming the stock makes it that far — is often more than capable of sending that bouncing stock back to the lows from whence it came.

Up, But Under: Two Bearish Bets for Traders Recap:

Jack in the Box (JBX). PowerRatings (for Traders) rating. 2

Micrel (MCRL). PowerRatings (for Traders) rating: 3

David Penn is Senior Editor at TradingMarkets.com.