In active trading, one of the most popular tools 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. In most cases, traders will want to confirm the buy or sell signal by using other technical indicators such as the moving averages or support and resistance levels. Using a combination of technical indicators is an effective way to increase the probability that a predicted move will actually occur. Let's take a look at a few stocks that are technically oversold and could be poised to make a move higher.
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Tidewater Inc. (NYSE:TDW)
Taking a look at the daily chart of TDW, you'll notice that the bears have been in control of the direction for the past several weeks. 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 above the 30 level - a sign that the recent selloff was overextended and that the bulls are starting to step back in. In addition, many traders will want to confirm the short-term buying pressure by watching for other bullish signals to occur. In this case, you'll notice the stock has fallen toward the medium-term support level that is illustrated by the horizontal trendline. The recent bounce off the trendline could suggest that buyers are starting to step back in. Specifically, it is interesting to note that the $41.20 level has propped up the price in the past (shown by the black arrows) and traders will use the move off this level to suggest that the stock is forming a base. It wouldn't be surprising to see many bullish traders set their stop losses below the support level because it would allow them to be protected in case the market correction continues.
L3 Communications. (NYSE:LLL)
LLL 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, recent 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 move higher. The chart is a textbook case of how levels of support and resistance can often switch roles. In this case, the $80.75 level acted as a strong level of resistance for most of 2009 and now that LLL is trading above it, traders will expect it to become a strong level of support. (For a quick refresher on this topic, check out Support And Resistance Reversals.)
Eli Lilly & Co. (NYSE:LLY)
Taking a look at the chart of LLY, you'll notice that the stock has been dominated by selling pressure and, as a result, the price has been pushed into oversold territory. The recent cross back above the 30 level on the RSI indicator suggests that the bounce off the $32.25 level might have more merit than the bears are giving it credit for. This chart looks very similar to the others and it wouldn't be surprising for traders to set their stop losses directly below the medium-term trendline (shown by the horizontal line). A break below this level would likely be encountered by a flood of sell orders, and could therefore be used as a sign that there is more selling pressure to come.
Arcelor Mittal (NYSE:MT)
The last chart that I've chosen to look at today is MT because it is also in the process of bouncing off an interesting level of support.
The rising RSI value combined with the bounce off the $28.75 level suggests that the long-term base is still intact and that the current price level could make for an interesting long-term entry position. As mentioned in the charts above, the RSI's recent move above 30 will also be used by traders to confirm the recent strength and it could lead to a continued move higher.
Recent market weakness has sent the share prices of all the companies that are listed above to very influential support levels. It is my opinion that the recent selloff is presenting investors with strategic long-term entry positions and is offering a very interesting risk/reward scenario in each of the cases. As mentioned above, the RSI indicator's move above 30 also suggests that buyers are stepping back into the market and it may be used by other traders as confirmation of a continued move higher.
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