Up, Up and Overbought

After a day when the Dow rallied by nearly 400 points, it is little surprise to see so many stocks soaring. But are these stocks short term traders should be chasing, avoiding, or even betting against?

Traders are never more bearish than when stocks are moving lower day after day. And at the same time traders are never more bullish than when stocks are moving higher day after day. All else equal, there are few things more bearish than consecutive down days and few things more bullish than consecutive up days.

But when it comes to the stock market, "all else" is often not equal, at all. Stocks that look like they are headed for ruin often find buyers, reverse and start moving higher. Stocks that appear as if they will never move down again suddenly run out of new buyers and begin moving down aggressively as holders of shares begin profit-taking in earnest.

We have conducted a great deal of research on some of these types of situations, instances where conventional wisdom would suggest one thing, but experience--and millions of simulated short-term stock trades--suggest the other. And there have been few places where our research has been as out of step with conventional wisdom--and as instep with common sense--as when it comes to stocks making consecutive up days and whether or not these are stocks that traders should buy.

We found that stocks that made five or more consecutive up days--and were trading below their 200-day moving averages--actually underperformed the average stock in one-day, two-day and one-week timeframes. While this does not mean that traders should rush to short sell these stocks, it does mean that any true list of potential short candidates should include stocks that, while trading below the 200-day moving average, have been up day after day after day.

Typically, these are stocks that have been underperforming for some time, but have suddenly received an upturn in buying interest. Who knows who these buyers are? Some are likely value players and bargain hunters, while others are no doubt short sellers who have begun to cover their positions, bidding shares higher in the process. But whoever they are, none of them have much strong interest in seeing these stocks move higher in the short-term thus, when they do, there is a strong likelihood that the selling pressure that had reigned before the stock began its oversold bounce will resume once that bounce has played itself out.

To read more about our research into stocks that have made five or more consecutive up days, click here.

Here are five such bouncing stocks. All of the stocks in today's report have not only been up for five or more consecutive days, but also have 2-period Relative Strength Index values of more than 98. In addition, all five stocks have Short Term PowerRatings of 1 or 2. Based on our research, looking at millions of simulated stock trades between 1995 and 2007, we found that 1- and 2-rated stocks have tended to underperform the average stock over the next five days.

AES Corporation (AES | Quote | Chart | News | PowerRating). RSI(2): 99.13

Dollar Financial Corporation (DLLR | Quote | Chart | News | PowerRating). RSI(2): 99.29

Heartland Payment Systems (HPY | Quote | Chart | News | PowerRating). RSI(2): 98.68

PeopleSupport Inc. (PSPT | Quote | Chart | News | PowerRating). RSI(2): 98.48

Wind River Systems Inc. (WIND | Quote | Chart | News | PowerRating). RSI(2): 98.72

For more simple and straightforward tips on short-term stock trading, consider getting a copy of our free report, written especially for those who trade stocks in the short-term "sweet spot" of five to eight days. Click here to get your copy of 5 Secrets to Short Term Stock Trading Success"--or call us at 888-484-8220--and see what the TradingMarkets approach to trading can do to make you a better trader.

David Penn is Senior Editor at TradingMarkets.com.