Overbought Dow Stocks to Buy on Dips

While these overbought Dow stocks are likely to correct lower, look for successful tests of key support levels to offer good buy opportunities as they continue to lead the overall markets higher.

Stocks started off June on a weak note and the selling is likely to continue early this week. Given the severity of the recent decline, some may be surprised that the major averages are not yet oversold according to the monthly Starc band analysis.

The SPDR Diamonds Trust (DIA), which tracks the Dow Industrials, closed Friday at $121.01, which is 8.2% above the monthly Starc- band at $111.01. The Spyder Trust (SPY) closed Friday at $128.16, which is 10.3% above the monthly Starc- band at $114.95.

In addition to identifying those stocks that are overbought (close to the Starc+ band) and oversold stocks (close to the Starc- bands), monthly Starc band analysis can often help identify leading as well as lagging stocks.

For more on trading with Starc bands, click here.

After running this analysis each month, I then look at the ten most overbought and the ten most oversold stocks to see which charts are the most interesting. Basis the monthly Starc band analysis, the three most oversold stocks include McDonald’s (MCD), Johnson & Johnson (JNJ), and Procter & Gamble (PG). All are within 10% of their monthly Starc- bands, but all three still look vulnerable to further selling. Therefore, I decided to focus on the most overbought Dow stocks, whose relative performance, or RS analysis, indicates leadership over the S&P 500.

Click to Enlarge

At the top of the overbought list are AT&T (T) and Wal-Mart Stores Inc (WMT), which are both within 5% of their monthly Starc+ bands. I expect these two and many of the other stocks on the overbought list to be market leaders once the stock market turns around. Before the worst of the selling is over, however, there is likely to be some panic selling in these issues, which should provide good entry points for new positions.

Click to Enlarge

Chart Analysis: The monthly chart of AT&T (T) shows that it closed last month above resistance at $32.60, which goes back to 2008. The next major resistance is in the $40.70-$42.70 area.

• RS analysis rose in May and is very close to breaking through major resistance at line b
• Monthly on-balance volume (OBV) looks even stronger, as it has already moved well above the highs from 2007-2008, line c, and is leading prices higher
• Monthly OBV has been in a strong uptrend from the 2009 lows, line d
• Weekly OBV and RS analysis (not shown) are both positive. The weekly Starc+ band is at $35.28
• Initial price support now stands at $33 with stronger support at $32-$32.60

Wal-Mart Stores Inc. (WMT) has been unusually volatile in the past two months. In April, when news regarding the company’s Mexican operations hit the tape, WMT violated the prior four-month lows at $57.42, reaching $57.18 before reversing to the upside.

• May’s close at $65.82 was well above the multi-year resistance, line e, in the $63.90 area
• The completion of the long-term trading range, lines e and f, has long-term upside targets in the $83-$85 area
• RS analysis has moved above its weighted moving average (WMA) and the previous peak, which suggests that it is now a market-leading stock
• Monthly OBV broke its downtrend, line h, in late 2011 and is holding well above its rising weighted moving average
• There is first good support now in the $63.50 area with more important support in the $60.50-$61.50 area

NEXT: More Big Dow Stocks to Buy Near Support

Click to Enlarge

Coca Cola Co. (KO) staged an impressive breakout in March and hit a high of $77.82 in April. The May high was slightly lower at $77.74, and KO did close lower for the month.

• The stock was hit hard on Friday, closing just above $73 with next strong support in the $71.80-$72.50 area
• The monthly uptrend, line a, is in the $66 area
• RS line is still well above its weighted moving average and its uptrend, line b
• Monthly OBV staged an impressive breakout in early 2011 (line c) and is still well above its rising weighted moving average
• Weekly analysis (not shown) is still clearly positive but the daily analysis does allow for further weakness
• Initial resistance is now in the $74.31-$75 area

Verizon Communications Inc. (VZ) has moved up the overbought list, as it was the ninth most overbought last month and is now fourth on the list. The stock currently yields 4.9%. The monthly chart shows long-term resistance from 2007 at $73.02, line d.

• RS analysis improved sharply last month, moving above its weighted moving average and reaffirming its uptrend, line f
• Monthly OBV has surged well above the 2007 highs, as it broke its four-year downtrend, line g, late last year
• Last week’s lower close suggests a further pullback is likely
• Initial price support now stands at $40.40 with further support in the $39-$39.70 area
• Weekly Starc-band is now at $38.50

What It Means: The market bears are expecting the current leaders to also break down while the overall market drops further. While these market leaders are now starting to weaken, it is my view that their corrections will hold at first good support and they will then once again resume their leadership roles.

The “Charts in Play” Portfolio is already long both AT&T (T) and Coca Cola Co. (KO), while previous longs in Wal-Mart Stores Inc. (WMT) were stopped out for a 4.1% loss. My previously recommended buying levels for Verizon Communications Inc. (VZ) were not hit, but I’ll now look to buy on a correction.

How to Profit: For Verizon Communications Inc. (VZ), go 50% long at $40.16 and 50% long at $39.64 with a stop at $37.78 (risk of approx. 3.5%).

For Wal-Mart Stores Inc. (WMT), go 50% long at $62.46 and 50% long at $60.54 with a stop at $56.78 (risk of approx. 7.6%).

Portfolio Update
Buyers should be long Coca Cola Co. (KO) from $66.13 and should have sold one-third of the position at $77.20 or better. The stock is now closer to our stop at $72.66, which, if hit, could signal a pullback to the $70 area.

Buyers should be 100% long AT&T (T) from $28.57, a position that has turned in a gain of more than 18%. The stop level is at $31.77, and I advise selling one-third of the position at $34.11 or better.