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7 Extreme Stocks to Trade in This Volatile Market - views
BALTIMORE (Stockpickr) -- When you’re looking for trades to make in this volatile market, think “extreme.”
Stocks trading at price extremes -- either overbought or oversold -- can offer investors outsized risk/reward tradeoffs. They can also create trading opportunities in markets that aren’t offering much direction right now. But to find trades in overbought or oversold stocks, it’s crucial to know what you’re looking at.
For starters, when we talk about overbought or oversold, we’re not talking about a company being over or undervalued. Instead, we’re talking about price extremes in a stock’s momentum. Overbought doesn’t mean that a stock costs “too much” -- only that it has accelerated more quickly than the market typically allows.
We’re using the 14-day relative strength index (RSI) as a way to measure whether a stock is at price extremes; generally, when RSI climbs above 70, a stock is considered overbought -- and it’s considered oversold on a slide below 30.
One of the most common myths about momentum is that overbought or oversold conditions mean that it’s time to bet on a reversal. In fact, a number of studies have shown that stocks that become overbought are statistically more likely to continue higher in the short-term than they are to reverse. That’s why looking at technical price action is crucial to trading these names at extremes.
With that, here’s a look how to trade seven stocks sitting at extremes right now.
Exreme: Oversold; RSI at 29.64
Nearest Resistance: $23.50
Nearest Support: N/A
It’s been a rough year for Cree (CREE). Shares of the $2.3 billion semiconductor firm have slid more than 68% in 2011, ravaged by poor guidance and analyst downgrades. While the selling has been constant this year, it’s accelerated since the start of November, resulting in an oversold reading in RSI of 29.64.
And investors shouldn’t count on this stock finding a floor in the near-term. Shares broke down below their $23.50 support level earlier this month, plunging to new multi-year lows; now, that support level is resistance for shares. Instead investors should look for a shorting opportunity on the next bounce off of resistance.
Exreme: Overbought; RSI at 70.63
Nearest Resistance: N/A
Nearest Support: $41
Almost the exact opposite pattern is taking place in shares of home improvement retailer Home Depot (HD). This stock has consistently bested analyst expectations this year, rallying nearly 20% since the start of January. More impressive is the stock’s rally from its August lows, a substantial move that’s still being confirmed by a similar uptrend in RSI. As long as that RSI uptrend remains intact, traders are getting a “buy” signal on HD.
Eventually, that uptrend will come to an end, however. When it does, it’s not a sell signal for shares. Momentum is a leading indicator of price, which means that it can act as an “early warning system” for a stock’s price. That said, the exit signal on Home Depot only comes from price itself.
With this week’s breakout above $41, I’d be looking for a pullback that retests our newfound support level as an even better buying opportunity.
Plains All American Pipeline
Exreme: Overbought; RSI at 79.29
Nearest Resistance: N/A
Nearest Support: $66.70
They don’t get much more overbought than Plains All American Pipeline (PAA), a stock whose RSI level rings in at 79.29 right now. Plains has been rallying hard in the last month, climbing more than 11% as investors pile into this energy sector holding. That upward momentum is more than just good for near-term prices; shares of Plains pushed their way to all-time highs this month, a move that has major psychological consequences.
Hitting all-time highs is technically relevant because it has everything to do with how shareholders approach this stock. Not only is every PAA shareholder who’s ever bought sitting on gains right now, they’re also getting a 5.6% dividend yield right now. Both of those factors reduce incentives to sell, tipping the scales toward a demand imbalance for PAA.
For now, it’s still a good time to be a momentum buyer.
Plains All American shows up on a recent list of 5 Large-Caps Flirting With 52-Week Highs.
Research In Motion
Exreme: Oversold; RSI at 22.36
Nearest Resistance: $16
Nearest Support: $12.45
Research In Motion (RIMM) has been Wall Street’s whipping boy for a while now, eroding most of shareholders’ equity -- over 76% this year -- as rivals such as Apple (AAPL) took vast amounts of market share from the once-dominant BlackBerry. But the carnage could be ending thanks to a reversal in RSI.
While it’s a mistake to sell just because RSI goes oversold, the swing from oversold to neutral (crossing above 30) can be a much more important buy signal. That’s what we’re seeing in RIMM now, with shares up more than 10% today thanks to an overcorrection from a post-earnings selloff.
I’d recommend sitting on the sidelines until nearest resistance at $16 gets taken out. More eager traders who want to take a position now would do well to keep a protective stop at $12.45.
Research In Motion shows up on a recent list of 6 Tech Stocks to Avoid in 2012.
Exreme: Oversold; RSI at 22.38
Nearest Resistance: $51.50
Nearest Support: $35
A new 52-week low is psychologically important for the same reasons that a new 52-week high is: With everyone who bought in the last year sitting on losses, their willingness to sell Sears is greatly increased. That could spur shares to fall into even more oversold mode before the year ends.
Last Thursday’s breakdown below $51.50 was a strong sell signal. Now, with nearest support at $35, this stock has considerably further to fall before it hits any meaningful pockets of demand.
While it’s likely that selling will stall before we hit $35, this still looks like a good time to be short Sears.
Natural Resource Partners
Exreme: Oversold; RSI at 29.23
Nearest Resistance: $30
Nearest Support: $24
Natural Resource Partners (NRP) is a $2.7 billion coal MLP that owns properties spread throughout the U.S. Right now, this stock is getting sold off hard, approaching a strong support level at $24 for the third time this year. With shares sitting close to that level right now, traders should be looking to play a bounce as demand comes back into shares.
This stock’s nearest significant resistance level at $30 puts considerable upside in trading shares to the top of their range. An 8.8% dividend yield also sweetens the pot, particularly as coal prices sit above their historic levels. I’d recommend a protective stop just below $24 on this trade.
Exreme: Overbought; RSI at 72.49
Nearest Resistance: $26.40
Nearest Support: $24
For-profit education firm Education Management (EDMC) is showing traders one of the more attractive near-term setups right now, thanks to a recent breakout above resistance at $24. While the for-profit education industry has been under pressure for most of 2011 as new regulatory pressures threaten to derail Federal loan funding, EDMC has actually had a very bullish run for the year -- shares are up more than 37%.
With resistance at $26.40, now looks like a good opportunity to take a long position in EDMC. I’d suggest putting a protective stop just below $24 to avoid against having this trade turn around on you unexpectedly if sentiment changes.
To see these stocks in action, check out the at Overbought and Oversold Trades portfolio on Stockpickr.
-- Written by Jonas Elmerraji in Baltimore.
At the time of publication, author had no positions in stocks mentioned.
Jonas Elmerraji, based out of Baltimore, is the editor and portfolio manager of the Rhino Stock Report, a free investment advisory that returned 15% in 2008. He is a contributor to numerous financial outlets, including Forbes and Investopedia, and has been featured in Investor's Business Daily, in Consumer's Digest and on MSNBC.com.