One of the most popular tools in technical analysis that is used to predict a shift in a stock's momentum is known as the relative strength index (RSI). This indicator's primary purpose is to determine when a given rally is becoming overbought or oversold. Generally speaking, readings below 30 suggest that the stock has been pushed to an unjustifiably low level, causing most bullish traders to start looking for a strategic entry position. On the other hand, readings above 70 are often used to suggest that the rally is getting exhausted and that the bears may be getting ready to send the stock lower. In most cases, traders will want to confirm the buy signal by using other technical indicators to increase the probability that a move higher will actually occur. Let's take a look at a couple of stocks that are technically oversold.
The Cheesecake Factory Inc. (Nasdaq:CAKE) - Taking a look at the daily chart of CAKE, you'll notice that the bears have been in control of the direction for the last several months. Notice how the selling pressure has caused the RSI to fall below the 30 level. Generally speaking, an RSI reading below 30 suggests that a stock is oversold and that it may be a prime candidate for a move higher. Many traders will wait on the sidelines until the indicator is able to cross cross back above the 30, showing that the bulls are starting to step back in and that the recent selloff was overextended. In addition, many traders will want to confirm the short-term buying pressure by watching for a bullish signal to occur on other major indicators. In this case, you'll notice that the MACD is in the process of crossing over its trigger line, which could be used to suggest that the stock has found a short-term level of support.
Wachovia Corporation. (NYSE:WB) - WB is another company that has been dominated by bearish price action, which has caused the RSI to fall into oversold territory. As you can see from the chart below, today's price action has caused the RSI to move above the 30 level, which will likely be used by active traders to suggest that the bulls are getting ready to stage a short-term move higher. It is important to note that the long-term direction of the trend is downward, as shown by the descending trendline; however, the recent spike in volume combined with the rise in the RSI suggests that we could see the price move toward the trendline over the short run.