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A Perfect Set-Up for Trading the DownsideBy Jeff ClarkTuesday, December 4, 2007 There are some things you just don't do.
You don't spit into the wind. You don't order sushi at a Tijuana truck stop. And you don't short sell stocks into weakness.
I tried to make that final point last Monday at the Alliance Conference in Playa Del Carmen, Mexico.
The stock market sold off sharply during the day, and the S&P 500 had fallen below its August closing low. No matter how you slice it, that's a bearish development. You could feel the claws of the big, hairy beast grabbing hold of just about everybody in the room.
And for the first time in several years – in a public forum – a conference attendee asked me which stocks I would sell short.
I was a bit stunned. You see, short selling – betting on the downside of stocks – is a favorite pastime of mine, but it's not all that popular with most individual investors. Part of that has to do with the fact that short selling is tough. Stocks have a bullish bias over the long term. So betting on the downside is a bet against the odds.
But there's something deliciously sinful about profiting while the market is falling. And the market's recent activity has investors looking at short selling like Adam must have looked at the forbidden fruit.
Monday, however, was not the right time to take a bite.
I answered the investor's question and rattled off a list of stocks that I thought looked like good short-sale candidates. But I pre-empted all that with the following comment... "Now is not the right time to start short selling stocks. Wait for a bounce first."
You don't chase stocks higher in a bull market. Rather, you wait for the inevitable pullbacks and buy stocks on the dips. In bear markets, you don't short sell into weakness. Instead, you wait for the inevitable rallies and you sell into strength.
So, if this is a bear market (something that I'm not quite convinced of just yet), then last Monday was the absolute worst possible time to initiate short sales. The action since then, however, opens up a realm of possibilities...
It's quite common for the market to retrace 50% or more of a dramatic one-way move. A 50% retracement on the S&P 500 from the October 11 high to Monday's low works out to somewhere around the 1,482 area. So, with the S&P closing at 1,481.15 last Friday, now is as good a time as any to initiate a few short sales – if you're so inclined.
Personally, I DO NOT think the market is going to crash and burn right now. In fact, I think the major indexes are going to work themselves higher over the next few months.
But there are several sectors that look vulnerable to sharp declines. And last week's rally set them up almost perfectly for anyone looking to sell short.
Best regards and good trading,
Jeff Clark
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