Selling Strength: More Overbought Stocks for Traders

Yesterday, with the markets rallying, there were a number of stocks that were increasingly overbought that looked vulnerable for reversal. But just because the market has continued to move higher for a second day does not mean that we should take our eyes off the ball: weak stocks that are experiencing temporary strength on the back of a rising broader market.

One easy way to tell if you are on the right track when it comes to deciding which stocks you should be trading and whether or not you should be looking to buy or sell is to use our TradingMarkets Stock Indicators. Every morning as I am compiling our pre-market morning e-mail newsletter, Morning Coffee with TradingMarkets, I check to see how many stocks are up 10% or more over the past few days and how many stocks are down 10% or more. I check to see how many stocks have 2-period RSI values of more than 98 and how many have 2-period RSI values of less than 2. I check for big gap ups and big gap downs.

What this does is paint a picture of the market for me before the bell sounds to begin the trading day. By consulting the TradingMarkets Stock Indicators I could tell, for example, that stocks were moving higher (some of them precariously so) and that the next big opportunity was likely to be selling the weaker stocks that have been moving up, stocks that had been lifted by the larger tide of the market.

Some may say: but the market is rallying! You should be looking for stocks to buy! This certainly represents the conventional wisdom when it comes to trading stocks: buy them when they�re going up and sell them when they�re going down.

But the TradingMarkets approach to trading is to buy weakness and sell (or short) strength. This means that when we spot rising markets we look for signs of exaggerated strength in weak stocks. One example of exaggerated strength is to be up by 10% or more in five days. When we remember that some markets are lucky to rally by 10% for the entire year, it is easy to see why a stock that moves so far so fast should draw trader attention.

Another example of exaggerated strength is an extremely high 2-period Relative Strength Index value. Given that the RSI runs from 0 to 100, we feel that a 2-period RSI which has reached 98 or higher is probably pretty indicative of a market exhibiting exaggerated strength.

All five stocks in the listing of overbought stocks for today have displayed both varieties of exaggerated strength. All five are up 10% or more over the past five days. And all five have 2-period RSI values of 98 or higher. While these stocks may not start falling immediately, if they remain on their current course, they all are likely to be among the first to fall as soon as the broader market takes a breather and begins to correct and move lower.

Smith & Wesson Holding Company (SWHC | Quote | Chart | News | PowerRating). PowerRating 3. RSI(2) 98.26

Celadon Group (CLDN | Quote | Chart | News | PowerRating). PowerRating 3. RSI(2) 98.05

Carter Holdings Inc. (CRI | Quote | Chart | News | PowerRating). PowerRating 2. RSI(2) 99.15

Jo-Ann Stores Inc. (JAS | Quote | Chart | News | PowerRating). PowerRating 1. RSI(2) 99.92

Human Genome Sciences (HGSI | Quote | Chart | News | PowerRating). PowerRating 1. RSI(2) 98.21

David Penn is Senior Editor at TradingMarkets.com