Traders looking to buy stocks have been rewarded with a number of positive opportunities in strong stocks that are pulling back to support. But traders looking to bet on stocks that may have gone too far too fast need not despair: our TradingMarkets
Stock Indicators have uncovered a few names that short-side traders might want to keep in mind in the days to come.
What makes these four stocks stand out is simple: they all have 2-period Relative Strength Index values of more than 98. In layman's terms, these are stocks that have moved higher and higher and higher over the past few days, virtually without pause.
So what's wrong with that? Theoretically? Nothing. Quantitatively? Plenty.
Our research into short-term stock behavior between 1995 and 2006, research that involved thousands and thousands of simulated trades, confirms that the more stocks move up, the more likely they are to move down. So when stocks become overbought based on a technical indicator like the Relative Strength Index, we as traders start to become interested in those stocks as potential candidates for reversal back to the downside.
There are two important aspects of this, however. The first is that it makes little sense to tilt at windmills by trying to bet against strong stocks. We define strong stocks simply: stocks that are trading above their 200-day moving averages are generally strong, and stocks that are trading below their 200-day moving averages are generally weak. So when we are talking about overbought stocks, we want to focus on WEAK overbought stocks, not strong overbought stocks.
The second aspect is that the indicator or tool used to determine whether or not a market is overbought or not must be very discriminating. Truth told, for all the years I wrote about technical analysis, I was never really a fan of the Relative Strength Index as a tool for spotting overbought markets. Why? Because far too many times, a stock would become "overbought" according to the RSI, only to continue moving higher and higher.
I found this tendency among oscillators to be so troublesome that I actually started developing trading setups that called for BUYING markets as soon as they became overbought by traditional technical indicators such as the RSI and the stochasticâ€"
