Four Ways To Find Decent Short Candidates

  • December 15, 2003
  • Rob Hanna

From
the market reaction, you would have thought the fat bearded guy
that US forces
captured this weekend was Santa Claus. It’s never a good sign when the
market fails to rally on good news…and the news doesn’t get much
better. Not only did the market fail to rally, but we saw another day of institutional
distribution today. One thing I’ve stressed to be on the lookout for is
institutional distribution. Here’s a peek at the Nasdaq with accumulation
and distribution labeled.

 

image src=”https://tradingmarkets.com/media/2003/Hanna/rh121503-01.gif” />

 

In the last nine trading
days, I’m counting four days of institutional distribution — and
no accumulation. (Last Wednesday was borderline, so if you want to call it three
or 3.5 days, that’s fine. It’s still not good.)

 

Here’s the S&P
500. (Accumulation/distribution is labeled for the previous four weeks or so.)

image src=”https://tradingmarkets.com/media/2003/Hanna/rh121503-02.gif” />

 

Here we see three days of
distribution and one day of accumulation in the last nine. Better, but still
not good.

 

The S&P and Dow have
managed to hit new highs lately — something the Nasdaq has not done. The
Nasdaq has led this rally since March. In the last few weeks, it has certainly
began to lag the other indices. The best spin I could put on it is that there
appears to be a rotation out of many of the smaller cap leading stocks into
large caps — but that’s a little too rosy. As you can see, distribution
is occurring in large caps as well.

 

Last Wednesday
I pointed out some leading stocks that were breaking down or reversing. They
aren’t looking any better today. It may be the “Season of Giving”
right now but that doesn’t apply to profits you’ve earned over the
course of the year. I believe it would be prudent to get a little defensive
right now. I would continue to suggest extra caution with any new long positions.
(Extra caution means reduced position size, tighter stops, taking partial profits
quicker and/or only taking what you consider to be ideal setups.) You should
also consider using tighter stops on a least a portion of existing long positions.

 

For people looking for short
exposure, there are a number of ways find decent short candidates. Here are
a few:

 

    1. Look for leading stocks
      forming big-picture topping patterns. (Someone else’s stop may be your
      short trigger.)

 

    1. Look to short very extended
      leaders that appear to be reversing after exhaustion runs.

 

    1. Look to short underperforming
      stocks that are breaking down from consolidations and making new lows.

 

    1. Look for transitional-type
      short patterns like Dead Cat Bounces, (Landry) Bow Ties, or (Landry) First-Thrust
      Pullbacks.

 

 

Like the old man in Monty
Python’s “Quest for the Holy Grail,” the market rally is “not
quite dead yet,” but it sure is looking pretty sick. If accumulation
doesn’t enter the market pretty soon, and if nearby price supports (1860-1890
for the Nasdaq) don’t hold, a fairly significant selloff could ensue.

 

Until Wednesday,

 

Rob Hanna

 

robhanna@rcn.com