After 400 points to the downside in the Dow industrials over the past few days, is there any surprise that we are starting to see a number of quality pullbacks and set-ups for short term stock traders?
Big drops in the market tend to send traders into a panic - or into dedicated short selling mode. But we have found that if traders know both where to look and what to look for, large pullbacks such as the one we are experiencing right now can open the door to impressive opportunities when stocks recover from what can become dramatically oversold conditions.
First, where to look. We feel it is important for traders to limit their long stock trade candidates to those stocks that are trading above the 200-day moving average. These are the stocks which, according to our research, are more likely to outperform the average stock than those stocks that are trading below the 200-day moving average. We even go so far as to call stocks that are trading above their 200-day moving averages "strong stocks" and those that are trading below their 200-day moving averages "weak stocks."
This one distinction can go a long way toward helping traders steer clear of trade opportunities that may seem attractive on first glance but are, after reflection, really not high percentage trades.
Second, what to look for. Once you have trained your sights on stocks trading above the 200-day moving average, you want to look for stocks that are pulling back from their highs. And though it may sound crazy, the deeper the pullback the better.
Once we are dealing exclusively with strong stocks, the more they fall, the more attractive they become as potential trade opportunities to the long side. Our research has shown that the further a strong stock falls, the larger that stock's subsequent bounce is likely to be. To that end, we often look for the stocks that would appear to the average trader's eye to be among the hardest hit, sharpest correcting stocks we can find. As long as those stocks are above the 200-day moving average, their weakness is to be welcomed not shunned.
Of course our Short Term PowerRatings play a big role in this - and fit very well within our construct of where to look and what to look for. When we look at stocks above their 200-day moving averages, we are also looking for stocks with high PowerRatings. This usually highlights those stocks that are already in pull back mode and have perhaps shown other signs of responding to an overbought situation (i.e., selling off for multiple consecutive sessions, or gapping down by 5-10% or more).
And when it comes to our Short Term PowerRatings and knowing what to look for we want to stick with the highest Short Term PowerRatings stocks possible. But we also want to buy these stocks at their lowest price possible. So here we look for opportunities to enter stocks with a limit order that is decidedly below the previous day's close - sometimes as much as 6% below - in order to make sure we are not chasing or paying too much for the trade.
In addition to all having dollar prices of less than $10 per share, three of the five stocks in today's report have Short Term PowerRatings of 10, while two have Short Term PowerRatings of 9. Our research on short term stock price behavior, looking at millions of simulated stock trades between 1995 and 2007, indicates that stocks with Short Term PowerRatings of 9 have outperformed the average stock by a margin of more than 13 to 1.
Stocks with Short Term PowerRatings of 10 - our highest rating possible - have performed even better, besting the average stock by a margin of nearly 17 to 1.
I have also noted the 2-period Relative Strength Index values for each stock as of the close of trading on Wednesday. We consider stocks with 2-period RSIs of less than 10 to be oversold, with stocks that have 2-period RSIs of less than 2 being extremely oversold.
PMC-Sierra (PMCS | Quote | Chart | News | PowerRating) Short Term PowerRating 10.
RSI(2): 8.36
Nautilus Inc. (NLS | Quote | Chart | News | PowerRating) Short Term PowerRating 10. RSI(2): 3.21
NextWave Wireless (WAVE | Quote | Chart | News | PowerRating) Short Term PowerRating 10. RSI(2): 1.31
Ford Motor Company (F | Quote | Chart | News | PowerRating) Short Term PowerRating 9. RSI(2): 1.58
Real Networks (RWNK | Quote | Chart | News | PowerRating) Short Term PowerRating 9. RSI(2): 9.60
Does your stock trading need a tune-up? Our highest Short Term PowerRatings stocks have outperformed the average stock by a margin of nearly 17 to 1 after five days.
Whether you have a trading strategy of your own that could use a boost or are looking for a way to tell the stocks that will move higher in the short term from the stocks that are more likely to disappoint, our Short Term PowerRatings are based on more than a decade of quantified, backtested simulated stock trades involving millions of stocks between 1995 and 2007. Click the link above or call us at 888-484-8220, extension 1, and start your free trial today.
David Penn is Senior Editor for TradingMarkets.com.
