The most overbought Dow stocks

Despite large first-quarter gains, 2 big Dow stocks show strong monthly chart formations and are worthy of new buying.

By Apr 2, 2012 5:27PM

By Tom Aspray,

The first-quarter gain of over 8% in the Dow Industrials was impressive, but many of the Dow stocks fared much better. One of the most oversold Dow stocks in the October scan was Caterpillar (CAT), which was up 17.6% in the first quarter, but it trailed the huge 38.2% gain posted by JPMorgan Chase (JPM).

My monthly scan identifies stocks that are closest to either their upper Starc band (Starc+) or lower Starc band (Starc-). Regular readers know that the proximity of a stock’s monthly closing price to its Starc bands is one reliable way to identify overbought and oversold stocks. (For more on Starc bands, please read “Buy, Sell, or Wait: A Way to Decide.”)

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Home Depot (HD) is at the top of the list and was up 19.6% for the first quarter. It ended the month just 1.4% below its monthly Starc+ band. IBM (IBM) is next on the list, trading just 4.8% below its monthly Starc+ band.

Despite its dramatic run in the first quarter, JPMorgan Chase (JPM) is still 6.2% below its monthly Starc+ band. It is also important to note that JPM is 45.6% above its monthly Starc- band.

An added benefit of this analysis is that it forces me to more carefully look at the monthly charts, which can often help to identify stocks that are breaking out above long-term resistance or dropping below long-term support. The monthly price ranges can often help determine key support levels that can be used for stop placement.

Two of the stocks on the list have very compelling monthly chart formations that warrant new positions.

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Chart AnalysisIBM (IBM) broke out of a 10-year trading range (lines a and b) in early 2010, point 1. It then pulled back for eight months before reaffirming the breakout in September 2010, point 2.

  • It has gained over 78% since the upside breakout and closed on its highs last month
  • The monthly Starc+ band is at $218.64 with the upside targets from the trading range in the $220 area
  • Relative performance, or RS analysis, broke its long-term downtrend, line c, in early 2007 and has since been in a strong uptrend
  • The on-balance-volume (OBV) also overcame its downtrend, line d, in 2007 and has confirmed the recent highs
  • Even though the monthly volume bars have been declining, the OBV indicates accumulation
  • There is first support now in the $200-$204 area with more important support at $194-$196

Coca-Cola (KO) was one of my favorites last month after it traded in a about a $5 range for the previous three months. In March, KO staged an impressive upside breakout.

  • This confirms the completion of the triangle formation, lines e and f, which has upside targets in the $96-$98 area
  • RS analysis has turned up from its monthly support at line g and could move back above its weighted moving average (WMA) this month
  • The downtrend in the OBV, line h, was broken in September 2010. The OBV made new highs in March and has confirmed the price action
  • KO has initial support in the $71.50-$72.50 area and then at $70
  • Major long-term support in the $65 area was overcome in April 2011

Though I favor the additional information that I get from candlestick charts, long-term chart formations are more striking when bar charts are used. Pfizer (PFE) broke its 10-year downtrend in February 2011 and then retested the breakout level last summer.

  • In March, multi-year resistance at line b was overcome, which is quite bullish
  • There is next resistance in the $23.50-$25 area with the major 38.2% Fibonacci retracement resistance at $26.15
  • This resistance was calculated from the 1999 high of $50.03, and the 50% resistance is at $30.75
  • Monthly OBV broke its downtrend, line d, in March 2011, and has turned up from its rising weighted moving average
  • Weekly and monthly RS analysis (not shown) are both positive, and the weekly OBV also looks strong
  • The formation from the last three monthly bars is positive. First support is at $22 with stronger support at $21

For the past three months (see circle), Wal-Mart (WMT) has traded above the major monthly resistance, line e, in the $61 area.

  • In 2008, WMT hit a high of $63.85, and the monthly Starc+ band is now at $66.97
  • WMT traded as high as $70.25 in 1999
  • A completion of the broad trading range, lines e and g, has initial targets at $78-$80 with further targets in the $90 area
  • Monthly OBV broke through its downtrend, line h, last November and closed strong in March
  • The monthly RS line (not shown) is below its weighted moving average but does appear to be bottoming
  • There is initial support now at $59.40-$60.40 with stronger support at $58

What It Means: The importance of the long-term chart formations cannot be ignored, as they often help to identify stock trends that last several years. Also, when the market does see a significant correction, the big-cap Dow stocks are likely to hold up the best.

There are quite a few Dow stocks in my model "Charts in Play" portfolio, and the largest holding is Coca Cola (KO). I have also recommended Pfizer (PFE) and Wal-Mart (WMT) previously, and I would still look to buy both of these stocks.

How to Profit: For Pfizer (PFE), go 50% long at $22.22 and 50% long at $21.64 with a stop at $20.44 (risk of approx. 6.8%).

For Wal-Mart (WMT), go 50% long at $60.84 and 50% long at $59.74 with a stop at $57.78 (risk of approx. 4.1%).



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