The Dos and Don'ts of Short-Selling

It's shaping up to be an excellent season for short-selling, but chasing stocks to lower ground might not be the best way to play this falling market. That popular strategy gets overcrowded very quickly, triggering vertical squeezes that will wipe out the most promising short-sale patterns.

So, if you're having trouble getting your short timing right, take a giant step back and learn Farley's do's and don'ts of successful short selling.

DO short rallies, not selloffs. In other words, enter positions when the major indices are overbought and pushing into obvious resistance levels. Other short sellers, i.e., your competition, get shaken out after prices creep higher for a few days, ensuring easier profits when the market finally rolls over.

DON'T jump into short sales when the index futures get hit with automated selling programs, unless you're a daytrader that's prepared to scale out as the algorithms push into short-term support pivots. These programs are highly opaque, meaning you have no idea when they going to end suddenly and give way to a substantial bounce.

Retail HOLDRs

Click here for larger image.

Source: eSignal

DO short the weakest sectors. For example, the Retail HOLDRS Trust (RTH Quote - Cramer on RTH - Stock Picks) rallied up to resistance at the 200-day moving average and "round number" 100 in April, rolled over and broke the trendline of higher lows posted since March. A bounce back to that trendline will also tag the broken moving average, setting up a low-risk short-sale entry.

This small pattern on the major industry ETF also favors short positions in a wide variety of underperforming retailers that bounced after the March lows. My favorite setups include: Gamestop (GME Quote - Cramer on GME - Stock Picks), RadioShack (RSH Quote - Cramer on RSH - Stock Picks) and Saks Holdings (SKS Quote - Cramer on SKS - Stock Picks).

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