Shorting The Defensives
While the tech bear market is getting
long in the tooth, if you dig into the sectors, you still can uncover deteriorating
stocks with enough of a potential downside to take the odd short. That’s why I’m
paying closer attention to the so-called defensives — in this case, healthcare.
If you must short this late in the game, it’s probably a good idea to look for medium- and short-term trades in the areas that fell apart later in the bear.
When people start to accept a bear
market for what it is, many investors don’t run straight to cash or
fixed-income securities. Instead, they allocate into the supposed safe havens of
healthcare, consumer staples and other defensive stocks. These groups can stage
profitable countertrend rallies for weeks, even months. But eventually, the bear
gets around to breaking the backs of many of defensive long plays as well as the erstwhile momentum leaders. So
the tech crowd may extended well south of the best short entries, you can find
shortable pattern formations in the defensive names as the bear expands to
include them.
Shorting the defensives also gives you
some hypothetical protection against mark turns. If we are near a bottom,
chances are money will rotate into the economically sensitive companies and the
perceived value opportunities scared up by capitulation selling, which can
accelerate the selling in the defensives.
Let’s look first at Cisco Systems
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PowerRating),
Yahoo
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PowerRating) and Broadcom
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PowerRating). These stocks have been in powerful
downtrends for more than a year. All are trading at fractions of their
all-time highs. All have extended well below their 200- and 50-day moving
averages.
There are two ways to short: off a
reversal pattern indicating that a stock is shifting from uptrend to downtrend,
or off a continuation pattern, indicating that a stock, which has paused in the
midst of a downtrend, is in the process of resuming that downtrend. What the
medium-term short seller trader seeks in a continuation-pattern entry is a
well-established downtrend. Cisco, Yahoo and Broadcom head lower? Sure. But none
have “paused” — in the form of upward wedging action or
four-to-seven-week inverted patterns — to clear out the short-covering and
bottom feeders before resuming their downtrends.
Compared to the techs and the Nets,
the healthcare sector is in big trouble as well. However, it swam against part
of the current before peaking in late 2000. So this raises the odds of catching
more of a remaining down move than in a sector or group which has made a longer
extended run into new lows. You can see this in the Dow Jones Healthcare iShares
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PowerRating), an Amex-listed exchange-traded fund that tracks the Dow Jones U.S. Healthcare Sector
Index.
Now let’s look at Abbott Laboratories
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PowerRating). Abbott is a healthcare products company and thus represents a
defensive play. True to form, Abbott swam against the bear market, rising more
than 80% to its 52-week high of 56 1/4 high on Nov. 30, 2000, from its close of
30 15/16 on March 10 of that year (the date of the Nasdaq peak). Since then, the
stock has fallen in line with the general downtrend.
In January and February of 2001, the
stock tried to rally back but formed a lower high and rolled over. The reaction
move carried the stock above its 50-day and 200-day moving averages, then broke
back below them, meeting a key requirement of the inverted cup-with-handle. For
more on this pattern, see my report, Using Inverted Cup-With-Handles To Identify Shorting Setups.
The stock now is in an appropriate
area to form a handle. Ideally, it heads lower first and forms the handle just
above support at 42 a share, but these entries don’t always set up for our
convenience! Abbott Labs moved up 1.6% Wednesday on mediocre volume, closed in
the lower half of its range and put in an inside day following Tuesday’s
decline. You could set 1/8 point below the Tuesday low as your pivotal point. Of
course, use stops and position sizing on every trade!
For an introduction to combining price stops
with position sizing, see my lesson,
Risky Business. For further treatment of these and related topics,
check out the Money
Management area of TradingMarkets’ Stocks Education section.