An Easy Way to Scan for Opportunities

12/31/2012 8:00 am EST

Focus: STOCKS

Corey Rosenbloom

Founder and President, Afraid to Trade

Corey Rosenbloom explains why scanning for stocks that are extending away from their 200-day moving average is a simple way to find potential trade candidates.

My guest today is Corey Rosenbloom, and one of the things he blogs about is finding stocks that are extended from their 200-day moving average.  We are going to talk to him about that and why he does that analysis; so Corey, what is it about those stocks that are extended from the 200-day moving average that you like?

Sure.  I do a scan—a simple scan—it is looking at the price, percentage of movement away from the 200-day moving average.  It’s the level that institutions look at and it is a general reference for most traders, and so stocks that are most extended; so for example, a stock that trades at $50, let’s say; the moving average is at 40, that would be an extension of a $10 move, so we are looking at percentage of movement from that or under extended the same watch.

They started the trades at, say, if it is in the large downtrend and the stock trades at $50 but the 200-day moving average is higher; it is in $100?  That is 50% underextended.  The reasons to look at these are to show us two reasons: One, stocks that are in powerful trends; stocks in a general basis.  If those traders that wish to trade pullbacks or trade retracements need to find trending stocks.  This is one of many scans that can help do that; so look at the trade retracements into that trend; the second strategy is much more aggressive.  It is playing off of mean reversion; so stocks that are overextended tend to pull back or correct, so those that came in looking for actually reversal trades at the end of a long trend, these stocks can be the catalyst to provide further research.

All right; so the further they are extended away from the 200-day moving average, the higher the odds are that it is going to revert back toward that 200-day?

Not necessarily.  When the price is so overextended, it could be the sign of extreme momentum or extreme trend.  They are rare, but just because a stock is overextended does not necessarily mean that it is required to come back.  General mean reversion testing shows that in general, it does, but these stocks can actually, if you look at them on a chart—scan them and look at them in the daily charts, for example—you can see salient trends that have lasted many months—if not sometimes years—and we would not want to fight that from a trading standpoint.  What we would be looking for are stocks that are showing large divergences—lengthy divergences—in volume and momentum.  In different factors that tend to precede reversals, breakdowns of moving averages; breakdowns of trend lines; those are the candidates more suited towards mean reversion; not the ones that are strong with strong momentum; strong moving averages, and strong volumes supporting it.

Okay; so that 200-day moving average combined with something else that may be diverging from that higher stock price is what you are looking for.

Exactly.  These are scans; we are scanning; we are not looking to trade directly off of this.  These pique our interest.  These get names, what happens on them?  The reason I run these scans; there are multiple ways of doing this, but these stocks; it is a simple way that most traders can do this and it provides names that may otherwise not show up in more complex or complicated scans.  There is going to be much more different reasoning for that.  These help the average trader find names so they can either A:  Put on pro trend retracement trades in the direction of a strong trend or, alternatively if they are more of a fade or mean reversion or reversal strategies can look for other factors, divergences, V-spike reversals; head and shoulders patterns, for example; things that tend to precede reversals; these stocks can provide those as well.

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