In my “Technically Speaking” analyses, I’ll take a look at up to three stocks that have entered into either an overbought or oversold condition. Using a combined strategy, focusing on RSI and MACD as my leading indicators, I work to identify short term trading opportunities that have the ability to catch a tidy return from an anticipated snap-back correction.
While company specific news is always going to be the prime driver of a stocks trading pattern, it is also true that the market is quite imperfect when it comes to the valuation to a stock, especially when emotion takes the better part of discretion. More often than not, these imperfect analyses lead to the price of a stock being mis-priced, sometimes too high and sometimes too low. These inefficiencies, however, provide investors an opportunity to cash in on quick and short term opportunities.
Keeping in mind that this column is designed for short term trading, maintaining the discipline to take a profit when the trading objective is met is crucial. I rely less on near term data and more on the likely trading pattern for the next 72 hours. Although technicals are an imperfect measure, they do allow an investor to step aside from the emotion that ultimately plays a significant role in whether a trading strategy is ultimately successful.
The “Technically Speaking” plays are intended to recognize stocks that have a high probability of a 10% – 20% snap-back rally. It is up to the investor to follow the discipline required to exit the trade once the objective is met. In some cases, the focus on discipline and strategy may cause an investor to not enter a trade at all, especially when the initial price objective of a trade is not realized. After all, market’s will not always cooperate with a trader’s plan.
A Quick Lesson In RSI
A valuable tool to measuring the trend of a stock is the Relative Strength Indicator, commonly referred to as the RSI. The RSI trades in a range of 0-100, with a reading over 70 generally indicating that the stock is overbought, and is likely to retrace from the current levels. Conversely, a stock trading with an RSI of less than 30 generally indicates that a stock is oversold, and is likely to bounce higher from current levels. The closer the reading to either the 0 or the 100 level provides a stronger signal for the investor to consider. But, simply because the RSI is above 70 or below 30 does not mean that a trading opportunity is ripe based on the RSI alone. That’s why I use a combination strategy.
Investors need to understand in no uncertain terms that trading strictly on RSI levels is a quick and almost surefire method to lose your money. Trading, by any stretch of the imagination, is not that simple. In finding a confirmation of an RSI signal worth paying attention to, investors need to factor in volume, double bottoms and tops and the quickness of the move in the RSI.
While the RSI is a great tool, used in combination with the MACD allows the signal to become even stronger.
A quick Lesson In The MACD
The Moving Average Convergence Divergence (MACD) signal is a powerful tool in and of itself. However, when combined with the RSI indicator, the signal is better confirmed.
The MACD is regarded as one of the simplest and most effective momentum indicators available to traders. The MACD follows two trend indicators, which are known as moving averages. The MACD reflects the momentum of a trade, taking into account both the longer and shorter moving averages and scores them into a single oscillator. The blended average provides traders with a read on both momentum and trend, and provides a signal based on a crossover signal on a baseline scored at zero. However, be careful, the MACD is designed to provide a signal and should not be used to determine overbought and oversold conditions on its own. For that reason, I like to combine the RSI and MACD together to produce a more reliable signal.
Keep in mind, trading on technicals does not guarantee a successful trade. As always, stock specific news tends to trump all technical data and can reverse a trend instantaneously. For traders that want to take advantage of “Technically Speaking”, it is important that you follow three basic rules:
– Set your goal for the trades, be realistic in your strategy. 10% return is great for three days work
– Allow a technical trade to exist for 72 hours. If the signal has not stayed in tact, exit the trade.
– No trade, no problem. Sitting on the sidelines in an uncertain market or with a volatile stock is never a missed opportunity. If an investor lacks confidence in the trade, they will most likely fail to employ the necessary discipline required to open and close the trade successfully.
With that brief introduction to the “Technically Speaking” analyses, let’s analyze three stocks that have met both of my primary indicators, an RSI below 25 and an MACD trading at or below the 0 base line. Each represent a near term trading opportunity.