PowerRatings Chartology: 3 Top Pullbacks for Traders

Two days of strong gains in the markets have created a somewhat overbought condition in stocks, to which the markets are responding with selling in the first few hours of trading on Friday.

They don't call it swing trading for nothing. There is a rhythm to trading that can be discerned when following a sound swing trading approach: markets rally and become overbought, allowing us the opportunity to sell stocks into strength or to take short positions against particularly overextended stocks.

These overbought conditions inevitably lead to selling, which allows us to cover short positions at a profit and to scout for strong stocks that have experienced perhaps too aggressive profit-taking.

And so it goes, back and forth as each significant move in stocks provides us an opportunity in itself, as well as in paving the way for the next opportunity as stocks change direction.

Our Short Term PowerRatings help traders see this back and forth movement from overbought to oversold and back again, as we'll see in the PowerRatings charts below:

Sauer-danfoss Inc. (SHS | Quote | Chart | News | PowerRating) Short Term PowerRating 9. RSI(2): 6.35

Consider the PowerRatings chart of SHS above. Note how the stock developed a Short Term PowerRating of 8 in late May – upgraded from a 4 to an 8 in just a few days. The stock first closed with a PowerRating of 8 on May 30th at 31.02. Five days later, SHS closed at more than $34.

And as the stock continued to rally, its Short Term PowerRating fell, reflecting the increased overbought nature of the stock and the growing likelihood that the stock would pullback, potentially setting up another opportunity for a short term rally. While the deep pullback in the second half of June did not result in a strong move to the upside, SHS's current pullback and high Short Term PowerRating highlight the potential for such a move here in mid-July.

Petroleo Brasileiro S.A. (PBR | Quote | Chart | News | PowerRating) Short Term PowerRating 9. RSI(2): 3.65

Rallies following high Short Term PowerRatings pullbacks were less prominent in the past few months for Petroleo Brasileiro, which has been trending downward toward its 200-day moving average for the past several weeks. You will note the spike higher in the second half of May which led to a plunge in PowerRatings to 1 and helped set up the current low volatility pullback we still see in the stock.

Even so, we can see some interesting movement, such as the bounce in PBR from June 4 to June 6, when the stock went from a close of $65.50 with a Short Term PowerRating of 8 to as high as $71 just two days later. Traders will be looking for a similar reaction to the stock's current high PowerRating pullback.

Zoll Medical Corporation (ZOLL | Quote | Chart | News | PowerRating) Short Term PowerRating 8. RSI(2): 11.29

The last PowerRating chart we'll look at today is of ZOLL, which has a pair of instances in which high Short Term PowerRatings have beget rallies and low Short Term PowerRatings have warned of tops.

Consider, for example, the last two times the stock earned a PowerRatings upgrade to 9. ZOLL earned a 9-rating on June 9th with a close of $35.46. Three days later, ZOLL closed at $37.19 – and the stock's PowerRating downgrade to 3 signaled that it was time for traders to take profits. Another example of this took place just under a month later in early July, as a 9-rated ZOLL closed at $32.17 on July 2nd and, three days later, the stock was closing more than two points higher at $34.73.

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David Penn is Senior Editor at TradingMarkets.com.