The 4 most overbought Dow stocks

Proven technical measures show that it's a high-risk time to buy these market leaders.

By Jul 15, 2011 10:50AM
By Tom Aspray,

It has been a tough week so far for the major stock market averages, as ratings cuts and the increasingly hostile environment in Washington have cut several rallies short. The major averages have retraced up to 50% of their rallies from the June lows.

The bottoming formations in the Advance/Decline (A/D) lines are still intact, but that could change with another day or two of negative A/D numbers. The McClellan Oscillator has dropped from a high last week of +247 to Thursday’s close at -70. Stocks need to turn higher by early next week to keep the market in rally mode.

Despite the overall market weakness, there are some stocks that have bucked the trend and are trading nearer to recent highs than recent lows. Even the strongest stocks undergo corrections, so it is important to know when a stock is overbought because that is clearly not the time to buy. It can also be helpful to those who want to take some profits on existing long positions.

My favorite way to measure whether a market is overbought or oversold are Starc bands, as they can often alert us to price extremes. Last week, in discussing NetFlix Inc. (NFLX), I noted that it was “getting closer to the weekly Starc+ band at $305.” This week, the company announced a controversial new pricing plan and the stock rallied to a high of $304.79 before reversing to close Thursday at $286.62.

The action in NFLX illustrates why these four stocks—Microsoft Corp. (MSFT), International Business Machines (IBM), McDonald’s Corp (MCD), and Coca-Cola Co. (KO)—could be vulnerable in the week ahead.

Chart Analysis: Microsoft (MSFT) has had a sharp rally over the past five weeks and is currently 12.4% above the June lows at $23.69. Thursday’s close was just 1% below the weekly Starc+ band.
  • The weekly downtrend, line a, is currently at $28.16
  • The 18-month downtrend in the relative performance, or RS analysis, line c, has just been broken, suggesting that after many years lagging the S&P 500, MSFT may once again become a market leader
  • The action of the weekly on-balance volume (OBV) is less impressive, and while it is back above its weighted moving average (WMA), it is well below its downtrend, line d
  • The daily OBV (not shown) is positive, but it is also below its major resistance
  • There is first good support for MSFT at $24.80-$25.05
International Business Machines (IBM) closed last week at $176.49, which was just below the weekly Starc+ band at $178.08.
  • In late January (point 1), IBM surged above the weekly Starc+ band and traded above it for the ensuing two weeks
  • Just five weeks later, IBM was about 10% lower and had reached the Starc- band (point 2)
  • There is initial support at the uptrend, line e, which was briefly violated in June. It is currently at $170. More important support is at $165-$166
  • The RS analysis continues to look strong, as it is rising sharply after breaking through resistance, line f, early in the year
  • This indicates that IBM should continue to outperform the market. The longer-term RS support, line g, is well below current levels
  • The weekly OBV did confirm the recent highs and shows a long-term uptrend, line h

McDonald’s (MCD) has been one of my favorites since mid-April, and it recently closed last week at $85.69, which is just below the weekly Starc+ band at $86.89.
  • This week, the Starc+ band is at $87.70, and MCD closed Thursday at $85.81. The weekly Starc+ band was also tested in late May (point 2), which was followed by sideways trading for the next few weeks
  • The weekly Starc- band was reached in mid-January (point 1), which marked MCD’s low for the year
  • The RS broke through its downtrend, line b, on May 14 and has risen sharply since. During this period, MCD is up 6.3% while the S&P 500 is down 2.1%
  • The OBV looks strong but has not yet exceeded the May highs, line c. The OBV is well above its uptrend, line d. The daily OBV (not shown) did confirm the recent highs
Of these four stocks, Coca-Cola (KO) is the least overbought, as it has pulled back from last week’s rally high at $68.89.
  • There is first support for KO at $66.25 with the uptrend, line e, at $65.20
  • The RS bottomed in February and has made a series of higher highs and higher lows, line f
  • The weekly OBV is looking less positive, as it has not confirmed the recent highs and is likely to close below its weighted moving average this week
  • A break of key OBV support at line g would be negative and could signal a decline to the March lows at $61.29
What It Means: Though for the most part, these four stocks have been market leaders, they are not immune should the stock market decline continue. The close proximity to weekly Starc+ bands makes them more vulnerable, and the recent action in NetFlix (NFLX) serves to emphasize the risk of buying when price is close to the weekly Starc+ band.

How to Profit: In April, I recommended going 50% long MCD at $76.46, and in a June Trading Lesson, I raised the stop to $79.78. I would now recommend an even tighter stop at $81.36.

Given the deterioration in the weekly OBV, those long Coca Cola Co. (KO) should use a stop no lower than $64.23.
Tags: ibm
Jul 17, 2011 10:33PM
Smile Do know about others, but Microsoft seems to be a turnaround value play. They're getting ready to enter a very critical new product period between 9/2011 and 6/2012 with Windows 8 that should put them right in the middle of the mobile consumer market for smart phones and tablets. If they can maintain moderate EPS during the next two quarters with Office, Windows 7 and server products then expectations for Windows 8 could really raise P/S.  They can not however buck an overall market downturn if employment and growth turn more negative.
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