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Apple Approaching a Short-Seller Sweet Spot

NEW YORK (TheStreet) -- Watching a name you're interested in soaring higher can be tough to take sometimes. It's akin to your neighbors having the greatest party of the year and while you're stuck at home listening to the laughter.

After reporting earnings, Apple (AAPL - Get Report) ripped higher and continues moving upward. If you sat on the sidelines waiting for a pullback to buy, only to see the train leave without you, you should resist the temptation to buy at this level. In fact, experienced traders are viewing Apple's last three days as a possible short setup.

I've found over the years that many types of market behavior repeat over and over again. One consistent pattern you can bank on is a stock gapping higher after a headline event (earnings release is most common), followed by two additional days of higher price action.

AAPL Chart

On the third day, usually one of two things happen. The stock will gap higher once more at the open and fade lower, or it opens lower and continues to fade lower. More often than not, the fade will last through the entire day with the close at or near the low of the day.

There are no sure things on Wall Street and you won't find a rule book that states Apple must retrace some gains on Tuesday. Back testing of similar chart patterns suggest the odds of Tuesday closing lower than Monday exceed 60% if Apple closes above $582 on Monday.

I posted exact entry and exit criteria in RealMoney Pro that include a profit target and stop loss for active traders. It's the same trade I intend to make if Apple completes the setup. It's a short selling trade and isn't appropriate for everyone, but does offer an excellent risk vs. reward ratio.

During this incredibly busy earnings season, if you want to ring the register on a stock that has really jumped after reporting, you may want to use the same strategy. The key is that the original gap must be extreme in relation to its normal daily price moves, and it must continue moving higher for at least two more strong days. For example, a small gap of 3% isn't going to cut it.

JBLU Chart

The opposite is true also. Many times a weak stock will take three days for whatever sin it committed to fully wash out. Chicago Bridge & Iron (CBI), Flowserve (FLS), and JetBlue Airways (JBLU) gapped lower on Thursday and continued falling on Friday and Monday. Investors should consider weakness near the open as a likely low point.

Stepping in front of freight trains is not without peril and requires a quick trigger finger to exit if the market continues to discount the catalyst. However, selling when everyone else is already on board, or buying when everyone else has thrown in the towel provides a significant edge that can be exploited.

At the time of publication, Weinstein had no positions in securities mentioned.

Follow @RobertWeinstein

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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