“When a stock’s price gets higher than 1 standard deviation above its 50-day moving average, we consider it overbought. Stocks lower than 1 standard deviation below its 50-day are considered oversold.”

This is how Birinyi Associates, Inc. defines Overbought and Oversold in a recent article on its blog, TickerSense. Along with this description and this helpful table from 3StocksonFire.com, here is another interpretation of how we model Overbought/Oversold in a Strategy Session. Note: our first, alternate version of modeling Overbought/Oversold conditions appears here.

UPDATE Note: As oversold as these opportunities may be, they could still fall farther. We’ve seen many opportunities where rallies exhausted themselves and fell further. This makes the strategy a good method for finding entries for possible short sales. See the strategies listed in the links to this post (below) for an alternate way of finding exhausted rallies.

The Strategy:
We are looking for ripe oversold candidates using a combination of standard deviations and RSI indicators. Additionally this strategy serves its users well by avoiding most of the first 30 minutes of trading which can often behave differently than the rest of day. It takes into account the “10:00 AM (EST) reversal” effect that often occurs in the market in order to minimize false signals.

How Its Modeled:
The set-up includes these filtering conditions:

• Average daily volume > 1,000,000 shares
• Relative volume > 40% higher than average current volume
• 15 minute RSI between 25 and 50
• Stocks must be 4% or more below the 50-day moving average
• Stocks no higher than the 5th percentile of its Bollinger Band range
• We didn’t add it, but consider including a requirement that the stock be down a few days too. This requires a (-) number in the Min Up Days filter (e.g., -3)

The Bollinger band filter is our proxy for standard deviations. Stocks that are a standard deviation in price to the downside are at the bottom percentiles of their Bollinger Band ranges. All stocks meet the other observation that they be below the 50-day MA with our filter that does just that.

The alerts we select as triggers within this filtered universe are stocks that: bouncing back at least 25% from lows and stocks that are breaking out of short term channels.

Who Could Benefit
This strategy can be used by scalper traders and other short term traders who use this strategy after the volatility and mixed signals that can often characterize the opening 30 minutes. Another caveat with this strategy is that it tries to catch phoenixes on the rise – some may soar but some may simply rollover … and out.

Footnotes:

• Birinyi Associates article mentioned in this post, “Overbought/Oversold“, TickerSense.
• See the History of “Oversold, Phoenix”.
• Link to other Strategy Sessions here.
• Remember that these set-ups are sketches meant to give you an idea how to model your own trading plan. Use this ‘as is’ or modify it to your own liking as many others do. Know, however, that Trade-Ideas.com and all individuals affiliated with this site assume no responsibilities for your trading and investment results. The indicators, alerts and all other features are for research purposes only and should not be construed as investment advice.