S&P 500’s Most Overbought Stocks

10/10/2011 10:35 am EST

Focus: STOCKS

Thomas Aspray

, Professional Trader & Analyst

These stocks are strong performers, but a key technical measure indicates risk may be high for new buying. Keep watching them closely and look to buy at lower levels.

The rally from last week’s lows has been fairly impressive, as many stocks and ETFs show gains of over 10% in just a few days. Typically, sharp gains like this are more characteristic of a rally against the major trend.

Stocks are higher in early-Monday trading on new plans to support the Eurozone banks. A strong close Monday with strong A/D numbers could complete the bottom formations in the Advance/Decline (A/D) lines that we have been watching. This would put the market in a position to rally into the end of the year.

If last week’s lows in the stock market do hold, then those stocks and industry groups that are acting stronger than the market should be favored. This makes the relative performance, or RS analysis, especially important.

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The entry point plays a key role in whether any trade or investment will turn out profitably. The table above shows the ten stocks in the S&P 500 that are the closest to their weekly Starc+ bands.

Often times a stock will close at or above the weekly Starc+ band for a week or two before they complete a short-term top. Clearly, buying a stock at a level that is close to its weekly Starc+ band has a higher risk and generally requires a wider stop.

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Chart Analysis: International Business Machines (IBM) closed last Friday just $4 below the weekly Starc+ band at $186.40. On the weekly chart, you can see that IBM closed above the weekly Starc+ band in July and below the Starc- band in August.

  • Once above the all-time highs at $185.63, there are further targets at $195-$200
  • The RS analysis broke out in May and made new highs again last week. Therefore, IBM should continue to outperform the S&P 500
  • The weekly on-balance volume (OBV) did confirm the recent highs and has just closed back above its weighted moving average (WMA)
  • The daily OBV (not shown) is clearly positive and is acting strong
  • There is initial support at $176-$178 with more important support in the $165-$168 area

Reynolds American (RAI) closed strong last week and well above the July/August highs. The all-time highs from June at $39.87 are now being challenged. The weekly Starc+ band is at $40.93.

  • The RS line has surged to the upside over the past month and is acting stronger than prices
  • The weekly OBV is positive and confirmed the highs from early in the year. Volume increased last week
  • The daily OBV (not shown) has been positive since the latter part of August. It is acting very strong, though the daily Starc+ bands are also being tested
  • There is initial support now at $38.60 with more important support in the $36-$37 area
  • There is major support for RAI just below $31, line c

NEXT: 2 More Stocks with Strong RS Analysis

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Campbell Soup Co. (CPB) closed within 4% of its weekly Starc+ band, but the weekly chart still shows a pattern of lower highs and lower lows. The weekly downtrend, line a, is in the $34 area, line a.

  • The RS analysis has improved and appears to have completed a bottom formation, lines b and c
  • The weekly OBV has just barely moved above its weighted moving average and the overall pattern is still negative, as it shows a well-established downtrend, line d. It would take some time for the OBV to complete its bottom formation
  • The daily OBV analysis and relative performance (not shown) look better
  • There is first support at $31.70-$32.20 with stronger support in the $30.80-$31 area
  • There is support from the double-bottom formation in the $29.70 area

The weekly chart of Kimberly-Clark Corp. (KMB) shows that it has broken out of a major trading range, lines e and f. The breakout level at $69 was tested last week. There is additional support at $69.70-$70.40.

  • The weekly RS completed its bottom formation in August as it surged through resistance at line g
  • The OBV surpassed its downtrend, line h, in April. It formed a bullish divergence at the August lows and is now in a strong uptrend, line i
  • The daily OBV (not shown) is negative, so a further pullback is possible over the near term.

What It Means: For most investors and traders, the worst trades are generally attributed to a poor entry price. In hindsight, they often wish that their entry price was where their stop was placed, as a market will just stop them out before it turns around.

The proximity of prices to their weekly and monthly Starc+ bands can give an objective reading on how aggressive they should be when buying.

All of these stocks except for Campbell Soup Co. (CPB) are acting like market leaders and should be attractive buys at lower levels. CPB on the other hand will bear some watching, as despite the positive relative performance, the OBV remains weak.

How to Profit: For International Business Machines (IBM), go 50% long at $176.76 and 50% long at $174.14 with a stop at $165.86 (risk of approx. 5.5%). Cancel the order if $185 is hit first.

For Reynolds American (RAI), go 50% long at $38.66 and 50% long at $37.44 with a stop at $35.26 (risk of approx. 7.3%).

For Kimberly-Clark Corp. (KMB), go 50% long at $69.54 and 50% long at $68.84 with a stop at $65.82 (risk of approx. 4.8%).

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