SSS - Thoughts on the Short Side for Tuesday, August 9th, 2011

Published : August 9 2011 at 10:51 ET

We have never seen a drop in the market off the peak like what we've seen over the prior nine trading sessions. This sell-off has actually been worse than last year's "Flash Crash" sell-off in late April/early May 2010, and it is even worse than the initial sell-off seen in late 2008. Many leading stocks have been decimated, and a fair number of have broken down to or below their 200-day moving averages. 

Would-be short-sellers should keep in mind that at this precise juncture the short side of the market is very risky, as the market is primed to stage a reflex rally from here given the sharpness and steepness of the preceding sell-off.

In March/April 2000, which this sell-off reminds us of a little bit, the market broke off a little double top in late March and the NASDAQ plummeted 28% in just seven days. On the seventh day, April 4th, 2000, the market closed well off its lows, creating a huge "hammer" type formation on that day by closing at 4148.89 after hitting an intra-day low of 3649.11. The market then rallied for the next three days before rolling over again and finding new lows at the 3227 level six days later. Assuming that we should have a rally of at least 2-3 days here, short-sellers should be attuned to the market's position, keeping track of it in conjunction with reflex rallies in potential short-sale target stocks, such as PCLN. It is possible that in a sustained bounce in the general market indexes, PCLN could move well above its 50-day moving average in the process, so for now it is largely a waiting game. As more potential short-sale target stocks move up into potential resistance we will likely consider the short side much more viable. For now, let the market do what it needs to do, which is rally for a period of time that is currently unknowable with respect to its duration, and have patience to let optimal set-ups come to you rather than trying to force the issue too soon.

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