What Goes Up... 4 Overbought Stocks for Traders

When a market moves strongly higher, there are two kinds of stocks traders want to be interested in. The strong stocks that have pulled back, and the weak stocks that may have gone too far too fast.

Truth told, by the time the broader market is moving up, it is often too late to take advantage of most of the strong stocks that were pulling back. The TradingMarkets approach to trading calls for not just buying weakness, but buying intraday weakness. This means, in short, that when we spot an opportunity to buy an oversold stock, we actually want to see that stock move down even further before buying it

The same is true with regard to selling stocks short. When we see a stock that has all the characteristics of being overbought: extremely high 2-period RSI values, multiple consecutive highs, large gains in a short period of time—we would like to see that stock move even higher before we begin betting against it.

So when we have a market that is up big, pulls back, and then rallies again, it is true that we should look to see what stocks are still in pullback mode, perhaps still testing their 200-day moving average for support. But we should perhaps be even more vigilant for those stocks that arguably had no good reason to rally in the first place, and might be particularly vulnerable to reversal and a return to their previously underperforming ways.

Think about it. Who owns those stocks that are scuttling along the lows, their 200-day moving averages several points above their most recent close? More importantly, how quickly would many of those woebegone investors move to sell if there was just the slightest bounce in their beaten, battered and left for dead stocks?

This is part of the game of selling weakness during moments of temporary strength. While many undisciplined traders like to "bargain hunt" among the stock market roadkill below the 200-day moving average, our research suggests that the only short term edge in dealing with such stocks comes from selling them short. But not just selling them short. Rather we specifically want to "fade" the bounces, betting against the stocks when they are potentially at their most vulnerable.

Our TradingMarkets Stock Indicators help us do just that. On the bearish side, we have eight that specifically look at different conditions that our research tells us are indicative of markets that are overextended to the upside. All four stocks, for example, in today's report have experienced five or more consecutive higher highs--but have done so while trading below their 200-day moving averages. This contradictory combination—short-term strength in a context of longer-term weakness--is exactly what we want to see in a stock we are considering betting against.

It may seem counter-intuitive. After all, as I have said often, traders are never more bullish than when a market or a stock is up day after day after day or, in the case of these four stocks—making higher high after higher high. But context is key. Betting on stocks that are trading below their 200-day moving average just because they've made a number of consecutive highs is like betting on a sub-500 team that just managed to string together a few victories. Chances are that sub-500 team will resume its losing ways as soon as its little winning streak is done.

Click here to read our research into stocks that have made consecutive higher highs.

Note also the relatively high 2-period RSI values of each of the four stocks, which further underscores just how overbought these names are.

CBL & Associates Properties (CBL | Quote | Chart | News | PowerRating). RSI(2) 95.13

Casella Waste Systems (CWST | Quote | Chart | News | PowerRating). RSI(2) 95.40

Liz Clairborne (LIZ | Quote | Chart | News | PowerRating). RSI(2) 98.63

Sears Holding (SHLD | Quote | Chart | News | PowerRating). RSI(2) 95.65

Does your stock trading need a tune-up? Read our special, Free Report, "5 Secrets to Short Term Stock Trading Success" for a refresher course on not just why to buy low and sell high, but specifically how you can use intraday weakness in the market to do so. Click here to get your copy of "5 Secrets to Short Term Stock Trading Success" or call us today at 888-484-8220.

David Penn is Senior Editor at TradingMarkets.com.