SSS - Current Perspective on the Short Side

Published : May 17 2011 at 10:20 ET

The general market and leading stocks have been looking quite sick recently, but this is not necessarily a surprise given that the Market Direction Model went to a sell signal on May 5th. The NASDAQ never got above the fail-safe level on the upside during the market's recent rally attempt, so the signal held and it is now starting to reap some benefits.

With the market continuing to deteriorate, the short side of the market comes into play and currently our primary activity in this regard is monitoring which leading stocks experience sharp, high-volume breaks off their recent price peaks. This begins the process of building a list of former leading stocks that may be in the process of building topping formations, such as head & shoulders (H&S) formations or late-stage failed-base formations (LSFB). Because we are in the early stages of any potential correction or leg down in the market, the short-side of the market is still developing from our perspective. A stock like Finisar (FNSR) exemplifies what we might be looking for with respect to H&S formations, while a stock like Las Vegas Sands (LVS) is a good representation of an LSFB set-up. FNSR is breaking down off the peak of a potential right shoulder within an H&S formation, whiile LVS is breaking down through its 200-day moving average and may in fact be shortable here, using the 200-day line as your guide for an upside stop.

The weekly charts of FNSR and LVS make useful "models," FNSR for H&S patterns and LVS for LSFB set-ups, for the purpose of visually screening for new potential topping patterns as leading stocks continue to break down in any sustained downtrend. Members should monitor leading stocks for these types of breakdowns.

Keep in mind that the indexes are now at a critical juncture with both the S&P 500 and the NASDAQ flirting with their 50-day moving averages, which could also provide logical areas from which the market could bounce. Right now we would tend to look for a bounce to short into as the downside may be getting somewhat obvious here in the short-term. Remember that from our perspective the short-side of the market is still in the developing phases, with very few actionable situations unless one is intent on trying to short a leader off the peak, something that is not part of our shorting methodology. Please refer to the book, "How to Make Money Selling Stocks Short" (Wiley 2004) that Gil Morales co-authored with Bill O'Neil for more on our methods of shorting the market.

FNSR - A model for an H&S type of top.


LVS - a model for an LSFB type of top.

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