Not Buying the Bounce? Four Overbought Stocks for Traders

Investors' hearts -- and the markets -- soared yesterday on rate-easing remarks from Federal Reserve chairman Ben Bernanke. Unfortunately, both fell early this morning as news of rising consumer credit card defaults from American Express reminded everyone that the fear of recession continues to stalk stocks.

If you've been doing some stock stalking of your own, then consider these four names whose short-term strength may mask a significant amount of potential weakness. Whether markets are moving up or moving down, traders who stick to buying real strength and sell real weakness will almost always have opportunities to profit.

The short-term strength I am thinking about this morning has to do with overbought stocks that are trading below their 200-day moving averages. Stocks that are trading below their 200-day moving averages are stocks that investors should avoid, as Larry Connors pointed out in an article last fall, "Five Mistakes to Avoid in a Market Trading Below its 200-day Moving Average". "For every falling knife you may catch," he wrote, "you run the risk of getting sliced up along the way."

Trading below its 200-day moving average establishes a stock as weak. We can spot short-term strength by using the Relative Strength Index (RSI), especially the short-term, 2-period RSI that Larry Connors and Ashton Dorkins wrote about last year. The 2-period RSI is an improved version of Welles Wilder's decades-old Relative Strength Index, a version that is more suitable both for short-term trading and for spotting the sort of extraordinarily overbought and oversold conditions that often lead to markets reversing course and reverting to the mean.

(Click here to read our research into the two-period Relative Strength Index.)

Too often momentum oscillators register overbought and oversold conditions too early -- at least in the way that oscillators like the RSI are traditionally used. Shortening the period length and raising the bar for being overbought to 98 helps make sure that stocks that register as overbought are truly overbought.

Our TradingMarkets Stock Indicators page lists the screen that helps traders spot weak overbought stocks. This screen looks for stocks that are trading below their 200-day moving average, and have 2-period RSI values of 98 or greater. RSI values are included. I have also noted the 100-day historical volatility. When it comes to trading short-term, higher volatility is better than lower volatility, all else being equal.

HealthNet (HNT | Quote | Chart | News | PowerRating). PowerRating 3. RSI 99.23. H.V. (100) 21.42

Mylan Laboratories (MYL | Quote | Chart | News | PowerRating). PowerRating 3. RSI 98.55. H.V. (100) 27.33

Harmony Gold Mining (HMY | Quote | Chart | News | PowerRating). PowerRating 2. RSI 99.39. H.V. 46.11

Neurocrine Biosciences (NBIX | Quote | Chart | News | PowerRating). PowerRating 1. RSI 99.46. H.V. 118.05

David Penn is Senior Editor at TradingMarkets.com