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What do you think happens when a stock that is trading above its 200-day moving average becomes extremely oversold?
Our research, involving thousands of simulated short term stock trades since 1995, is clear: those stocks tend to go up.
As published Short Term Trading Strategies That Work - and as revealed through their PowerRatings stock rating system - Larry Connors and Cesar Alvarez have shown time and time again how oversold and overbought markets tend to revert to their mean in the short term, providing high probability trading opportunities for short term traders.
One of those clues to help spot an oversold market is the 2-period RSI. Specifically we found that stocks that were trading above their 200-day moving averages and had 2-period RSI values of less than 2 tended to outperform in the short term.
We've seen examples of this happen recently in stocks like Qualcomm (QCOM | Quote | Chart | News | PowerRating), which soared by more than 3% on Wednesday after closing for two days in a row with declining 2-period RSI values of less than 6 and less than 3.
Now look at Google (GOOG | Quote | Chart | News | PowerRating), which was significantly more oversold. The stock just spent the past two days leading into trading on Wednesday with closing 2-period RSIs of less than 2. Our research tells us that these extreme oversold conditions make Google more likely to outperform the average stock over the next few days.
The fact that shares of Google had earned a PowerRating of 8 going into Wednesday's trading was further testament to its potential to move higher in the short term. Stocks with PowerRatings of 8 have outperformed the average stock in our historical testing by a margin of more than 6 to 1 after five days.
For traders of Google, the clock is already ticking. The stock's 2-period RSI was in the 40s late on Wednesday as buyers became attracted to the stock's oversold extremes. Similarly, GOOG's PowerRatings slipped on an intraday basis to 7.
But there are a number of "big name" stocks - many of them in the technology sector - that are still in pullback mode. Here are three for PowerRatings traders to keep their eyes on.
eBay (EBAY | Quote | Chart | News | PowerRating) has closed lower for four consecutive trading days and ten out of the past 12. With a 2-period RSI of less than 7 late in trading on Wednesday, further weakness will likely attract buyers to this stock as it pulls back toward its 200-day moving average. EBAY has a PowerRating of 8.
Down three days in a row, Expedia (EXPE | Quote | Chart | News | PowerRating) has earned a 2-period RSI of less than 4 and a PowerRating upgrade to 8 late in the trading day on Wednesday. Shares of EXPE were down another 3%.
Research in Motion (RIMM | Quote | Chart | News | PowerRating) was down more than 3% on Wednesday and continues to have a PowerRating of 8. The stock has closed lower for four days in a row and is scheduled to report quarterly earnings Thursday after the market closes.
David Penn is Editor in Chief at TradingMarkets.com.
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