|
Now I am very much aware that many market
players do not like to short stocks. This bias
against the short side of the market is totally
understandable, especially given the fact that the
widespread reluctance is garnered and perpetuated
by the various exchanges and the other
powers-that-be. For example, one can only short a
stock if it is trading on an uptick. That one rule
makes getting shorts off (filled) extremely
difficult in declining markets. The reason for
this handicap of course is to prevent traders from
adding to the selling pressure. Yet there is no
bias of that nature directed against the upside.
The exchanges seem to have very little problem
with the market rising in an unfettered fashion.
Now, the number of stocks that can be made
available for shorting, even if they are trading
on an uptick, is being limited by the exchanges.
This further handicaps the short seller, and
clearly makes it known that the powers-that-be
don't want the public shorting. I don't know about
you, but whenever the higher-ups say "No, we don't
want you doing that," I ask, "Hmm, I wonder why
they don't?" That's me. I'm a questioner. Always
have been. Always will be. It's the way I'm wired,
I guess. Of course these rules are said to be for
the benefit of the "average investor," whatever
that term means. But we as professionals know this
to be untrue, at least to a certain extent. These
hindrances or barricades to the world of shorting
are to protect one of the last areas of really big
money. Small fortunes (and some not that small)
are made everyday on the short side of the market
by those professionals who do not have these
restrictions imposed on them.
A Specialist on the American Stock Exchange
(AMEX) does not have to wait for an uptick to get
short. Neither does a NASDAQ market maker, for
that matter. Again, my nature compels me to ask,
"Why? Why can they and not us?" It's the same
age-old reason, my friends. Money. Big money. And
instead of the little guy being let in on it, he
is being kept out, or at least discouraged, all in
the false light of "protection." The public is
being duped again, and many are buying it. "Why
short when the market is going up" is the loud cry
we hear from the establishment. Yet it's the
establishment who has conveniently made sure they
are free of these restrictions in this up market.
I smell a rat! And the stench is
incredible.
The
Theory
Stocks that are up robustly on the day, and
actually close near the day's high, are no doubt
very strong stocks. In fact, this strength,
particularly if a lot of it occurred near the
day's end, will typically lead to immediate upside
movement the following morning. The reason behind
this upside tendency is quite simple, though
relatively unknown. Many people forget or do not
realize that the job of a NYSE specialist or
NASDAQ market maker is to provide liquidity. This
means that if a stock is falling and there is an
absence of buyers, they must buy. Conversely, if a
stock is running up quickly and there are no
sellers to offset the buying, they must take the
other side as sellers. This often times puts the
specialists and the market makers at odds with the
trend and or the current momentum. In many cases,
the specialists and the market makers will
actually sell so much of their inventory
(personally owned stock) on the way up, that they
become what the industry terms, "net short." This
simply means that they have sold more stock than
they own and will have to buy the stock back lower
than their average short price if they are to make
money. Therein lies the key to our philosophy.
With specialist and market makers (large firms
backed by enormous amounts of money) short, they
have a vested interest in the stock dropping so
that they can cover their open short positions at
a profit. And believe me my friends, they will do
everything in their power to make it happen.
Otherwise they will lose, which they do at times,
and lose big. This is where we come in.
The
Approach
The focus of our approach is to join the
well-capitalized professionals (the specialists
and/ or the market makers) precisely when they are
the most interested in the stock going down. In
other words, we only want to think about shorting
when these heavy weights are also rich with open
short positions. This dramatically increases the
odds of our being right. To this end, we have
devised a very simple yet powerful approach to let
us know when to strike on the short side. We are
proud to say that the approach enjoys a very high
degree of accuracy, and as mentioned above, is
predicated on what the big money will be doing.
Let's take a closer look at what's required to use
this professional technique.
The
Tools
1) A daily price chart which
displays roughly three to six months of price
data. As many of you know, we rely on the price
chart to reveal the flow of money. An upward
movement in the price chart shows buying and a
downward price chart reveals heavy selling.
2) Standard Bollinger Bands (20
period exponential bands with 2 standard
deviations). This technical tool can be found in
every commercial charting package on the market.
Even sophisticated order entry systems like Mastertrader
and Real Tick III which give traders near instant
fills will have this study included. Let's move to
The Set-Up.
The Set
Up
1) The stock must first puncture and
close outside (above) the upper Bollinger Band.
The closer the closing price is to the high of the
day, the better. And the bigger the day's advance,
the better. As a general rule, you will want this
day's bar to be at least $2 or more in length from
high to low. This is not always necessary, but
it's better to have it.
2) On the following day, the stock
must "gap" down below the prior day's close. This
"gap down" is crucial as it serves as the most
important criteria of the entire strategy. If the
stock does not open for trading below the prior
day's close by at least 50 cents (preferably
more), no action should be taken. We need weakness
right at the open. Example: If on Tuesday the
stock closed at $40, we want to see the stock open
for trading on Wednesday no higher than $39.50. It
must open down!
Note: In many cases, this gap down
will be caused by either an exceptionally weak
market open or a negative news item on the
company, such as a brokerage downgrade. But in
either case, the gap down signifies major selling
(profit taking), and the pros who short will be
loving it. Keep in mind that both the above
criteria must be met before action is
taken.
The
Action
Once the above Set Up Criteria is met,
the trader will do the following:
1) Sell the stock short (at the
market if you have the luxury of being able to
kill the trade instantly in the event the stock
gets too far away from you). With order entry
systems like Mastertrader,
the trader will be able to instantly cancel the
open order, if need be. If the trader lacks this
"instant canceling" capability, he is better off
placing a limit sell order.
2) Once the short has been filled,
place a protective stop (mental or otherwise) 1/8
above the high of the prior day. This is our
insurance policy against disaster. If the stock
rises above the high of the prior day, that is our
sign that the shorts are being squeezed, and the
major advance has more steam left, as those short
will be forced to buy at higher prices to curtail
their losses.
3) Hold for two to three days or
more, protecting your profits on the way down with
some form of trailing stop methodology. Note: Some
traders may want to move their protective stop 1/8
above each prior day's high. This is called
"tracking the prior highs." Others may want to
"book profits" in the following manner: "Once up
$1, move stop to break-even. Once up $2, protect
1/2 of the gain, and once up $3 or more, protect
2/3 of the gain. Note: The idea is to ride the
short for maximum profits. But of course if the
trader is shorting a weak stock in the context of
a bullish market environment, booking the profits
sooner rather than later is preferred, even if it
means missing additional gains. We don't want to
fight the major flow of the market too long. A few
examples will make this clear.
|