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The Traders Wheel
12/27/98 by Alan Farley

Bear Hug

This dynamic bull market has taught painful lessons to those seeking profit from a stock’s decline. Many experienced traders now avoid the art of short selling completely and stick to popular momentum strategies. But well-rounded technicians miss out on high profit opportunities by avoiding clear setups that flag imminent declines. Take the plunge and overcome the bull by aligning your short sales to low risk market conditions.

Ironically, the completion of a short squeeze generates excellent conditions for short sales. As upside momentum ebbs, supply-demand imbalance shifts to the sell side and market players reverse the short-term trend. Using Fibonacci retracement, traders can measure a squeeze better than the insiders. This forced rally can't carry beyond 62% of the prior fall without real buyers. They often get washed out well before the squeeze ends.

Don’t chase a rapid decline with a market order. Without any up ticks, you’ll get crushed on a bounce just after getting filled. In fact, avoid short sales completely during dramatic falls. When chasing momentum, safe exits vanish and risk escalates dramatically.

The first rally into a sharp down gap provides a near-perfect short entry point. When the gap marks a breakdown from a topping zone, search for a stop gun low (doji or hammer) somewhere near the bottom of that pattern. This low bar flags where price will likely fail. But watch out. Price sometimes gaps back in the opposite direction. In that case, trades must be exited immediately as the prior signal is negated.

Another interesting short sale may arise when price constricts into a very tight range and volatility falls off. Positions can be taken within this quiet zone while random up ticks allow easy entry. If the trade works, price will quickly expand lower. Should price step out of congestion against your position, exit quickly. When other factors support a decline, this trade has an excellent reward: risk profile. Even with no cross-verification, you’ll know immediately when the trade fails and can cut your losses economically.

Remember the decade-long secular bull and its natural upward bias. This reduces the odds your short sale will be profitable. Rallies during weak market conditions offer the best environment for short selling. However, the smart trader can always locate weak stocks that no bull market can help. Concentrate on these before tackling the more difficult task of trading intermediate corrections in up trending issues.

asnd2.gif (9585 bytes) ASND’s 1997 bear market brought at least 5 excellent short sale opportunities. Each step of the decline generated a low risk entry point as price invariably tested the prior break in support. While horizontal price resistance marked a barrier in the last 4 cases, note how the first test arose from a break of the key 50-day moving average

 

Article contributed by The HARD Right Edge, which presents highly original tutorials, strategies and resources on multi-trend technical analysis and and short term trading. Article reprinted here with permission, which presents highly original tutorials, strategies and resources on multi-trend technical analysis and and short term trading. Article reprinted here with permission.
 
 

 

 
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Last modified: April 09, 2001

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