When you go long in the stock market, you often get more than one opportunity to accumulate shares in a single true leader. When a former leader peaks and begins a long journey south, you also usually get more than one chance to profit on the short side.
This monthly column has featured two primary patterns for a successful short sale: the head and shoulders and a fast plunge after a late-stage breakout.
The two patterns differ greatly. Yet they produce similarities on the second or possibly third entry point for a smart short seller.
How so? On a daily chart, watch how the stock interacts with the 50-day moving average. Ditto for the stock’s 10-week line on its weekly chart.
The 50-day moving average line plots a stock’s average closing price in the 50 most recent sessions of trading. After a stock falls sharply in big volume, it tries to recoup some losses.
If the rally lacks power and the volume lacks punch on either the daily or weekly chart, look at the 50-day and 10-week line, respectively.
Does the stock bump its head against the 50-day line, or near it, as volume fades, then shoots lower again? Or, does the stock pop briefly above the line, then sink back below it like a rock? If yes, then you’ve landed a new opportunity to sell shares short.
How many shares should you decide to short the stock? It depends. If you’ve already sold short at the initial entry point, always sell a smaller amount. Control your average selling price. If the stock rebounds, you don’t get caught with a loss on the position.
Also, look at the price of the second potential entry vs. the initial short sale entry. Has the stock already fallen 30%, 40% or more below the initial short sale point? If yes, then the potential for further decline is less. You may still decide to short the stock, but take a smaller size position than you would normally do so.
Coach (NYSE:COH) became a market also-ran after leading in retail accessories for many years in the 2000s. In 2012, both earnings and sales growth began to slow.
Coach formed a mini head-and-shoulders pattern from February to May 2012. It had earlier reset its base count, so it was not in late-stage base territory. But the retailer had powered a 599% run from its March 2009 low of 11.41.
After three quick, feeble attempts to reclaim the 50-day moving average, it triggered an initial short sale in the week ended May 4, 2012. A secondary entry came after May 29. The stock rebounded for a week and approached the 50-day line (1), but failed to reach it. Given that the market was in correction mode since May 4 that year, it was a good time to short.
A third short entry arrived when Coach rallied for two straight weeks in July, then crossed back below its 50-day moving average in fast turnover on July 30 (2). Coach dropped as much as 21% from the 50-day line in the next three sessions, allowing the short seller to cover quickly for a fast gain.
When a stock tries to rebound and gets near the initial entry on a head and shoulders pattern or a late-stage base failure, that also serves as a second chance to short the stock. The L-shape pattern (see the Feb. 2 column) provides an additional entry.
Read More At Investor’s Business Daily: http://news.investors.com/investing-the-short-side/050115-750609-short-selling-tips.htm#ixzz3Z1YF69B7
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