In This Market, It's Good to Be Short-Sighted

Two respected traders I know wrote articles over the weekend telling everyone how hard it's been to find good trades. If you haven't figured it out yet, this is code for "I haven't made any money, so I'm blaming it on the market."

In fact, we've been in a well-defined trend to the downside for some time now. Although breakouts and new highs may be drying up, these are salad days for short-selling. So it's not the market's fault if you've missed this wave of opportunity and put some money in your pocket.

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There is a right way and a wrong way to manage short sales. But many traders avoid shorting entirely because they can't think in terms of sell first, buy last. There's nothing wrong with this approach, but it only lets you trade half the market.

So if you're not ready to sit on your hands when you can't buy, take the plunge and learn to short sell. With a little effort, you'll be capturing upside-down profits while others are playing the blame game.

Let's look at five short picks from my newsletter, The Daily Swing Trade (DST), and see what strategies worked during this recent bear swing.

Source: qCharts

The DST picked out an E*Trade (ET - commentary - Cramer's Take) short sale right after it broke down from a small double top. This completed a bearish island reversal that often telegraphs a broader selloff.

We didn't have to wait long for the trade to work. E*Trade dropped 18% over the next two days before finding support. The trick with this trade was getting in early and getting a stop over the falling market. ET printed a long-legged hammer and a sharp bounce. If you hadn't booked your profits by then, the bullish candle was the signal to take the money and run.

Source: qCharts

Big clues come in small packages. Polycom (PLCM - commentary - Cramer's Take) rolled over to its 200-day moving average, where it completed an inverse cup and handle pattern, and NR7 bar.

This tiny signal represents the narrowest range bar of the last seven bars and often precedes a major price move. That became an understatement because Polycom dropped off a cliff for a 27% decline over the next four sessions. And selling short was as simple as placing a limit order during any pause in the decline. Polycom couldn't muster a single short squeeze during the entire event.

Source: qCharts

Concord EFS (CEFT - commentary - Cramer's Take) had a setup very similar to the Polycom short sale. But this one required quick reflexes and a direct-access trading terminal. Concord EFS broke down the day after the DST issued the call, but it fell with the speed of light. The stock dropped 3 points in a matter of minutes, and then began to recover. This produced windfall profits for intraday short-sellers, but a case of whiplash for anyone jumping in and walking away.

Source: qCharts

Digital River (DRIV - commentary - Cramer's Take) printed a Jan. 30 hole-in-the-wall gap, one of my favorite bear patterns. Like island reversals, this one-bar wonder often precedes broader selloffs. Digital River took the gap in stride, and bounced as soon as it reached a parallel price channel. This set up a 1-2 short sale, where the trade signals as soon as the channel breaks.

My call was a bit early, and Digital River bounced into the gap. This offered a more aggressive short sale, because all the investors trapped at the top were looking to get out on the bounce. After four more days of sideways action, Digital River broke the bottom channel and fell almost 3 points. After a weak bounce, the stock has now fallen almost 50% since the day before the gap.

Source: qCharts

It would be nice if all short sales worked out in our favor, but that's not the case. Genta (GNTA - commentary - Cramer's Take) printed a perfect selling pattern that trapped anyone believing their own eyes.

The stock broke through a descending triangle and bounced back to resistance in a weak rally. But Genta had a mind of its own. It moved up day after day into the formidable barrier, and then gapped though it on high volume. Genta was demonstrating one of the great market truths: Unexpected rallies begin exactly where great short sales do.

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Alan Farley is a professional trader and author of The Master Swing Trader. Farley also runs a Web site called HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. At the time of publication, Farley held no positions in any of the stocks mentioned in this column. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback and invites you to send it to [e-mail].

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