Bears Ground Continental Airlines

Buying interest has waned, setting this stock up for a short sale.
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Shorting stocks during such a volatile environment can be a bit nerve-racking.

After all, we fear getting caught in a short squeeze if the market suddenly explodes -- like Wednesday. But we also realize that having some hedges in a portfolio can really help mitigate the damage of a severe market downturn.

The market is experiencing persistent buying interest these days. Now, the bears can quibble with me about whether the action shows "persistent buying interest," but when equities are supposed to be falling because of rising bond yields -- but don't? The only reason that happens is because of, well, persistent buying interest!

With all three major averages up well over 1% yesterday, the best short candidates tend to be those stocks that did not participate in the rally. After all, if they weren't being bought during the feeding frenzy, what happens when all the bellies are full?

One stock that meets this criterion is

Continental Airlines

(CAL) - Get Report

.

I featured this stock a few months ago when it was trading at $37.95. Even though the stock traded lower, it ultimately triggered the buy-stop for a very small loss. Of course, I got the obligatory email from one or two fellows who took issue with my short idea, chastising me, "How dare you short my airline! Don't you know..."

Well, yes, I do know... But so does the market. In fact, the market knows a lot more than I or most other investors do; and according to the chart below, the market is not booking flights on Continental Airlines.

Let's take a look.

Between the September 2005 low of below $10 and the January 2007 high, the airliner's shares have advanced more than 500% on increasing volume. But if you look at the volume bars over the past six months or so, most of the heavy volume has occurred during distribution weeks, with advancing weeks occurring on noticeably lighter volume.

Continental Airlines (CAL) -- Weekly

Now, volume does not tell the entire tale. Stocks can fall on lower volume just as easily as on higher volume. In fact, I've often seen stocks undergo prolonged declines on lower volume, reflecting a lack of buying interest to prop the stock up. And when buying interest wanes, shareholders can become nervous and start to sell the stock.

That's what seems to be going on with Continental Airlines (though higher energy prices sure aren't helping matters either).

A prudent short entry would be at about $33.40, and I suggest keeping a buy-stop up at around $36.50. A maximum downside target of about $18 is possible, though I wouldn't expect the stock to get there overnight.

Continental shares closed at $33.48 Wednesday.

Updates on Previous Picks

  • Last week's pick, Arrow Electronics (ARW) - Get Report, remains on the Watch List with an entry of $40.90. The stock closed at $40.52 Wednesday.
  • Assisted Living Concepts (ALC) - Get Report: The entry of $11.60 is still profitable, but Lehman Brothers just began coverage of Assisted Living with an overweight rating and a price target of $13. The stock was up almost 4% yesterday. The buy-stop is at $11.90, and it remains unchanged. Shares closed at $11.39 Wednesday.
  • Goldcorp (GG) is also on the Watch List. Wait for this short pick to run back up to $25 to get a better entry. So far, that hasn't happened. Shares closed at $24.12 Wednesday.
  • Lam Research (LRCX) - Get Report: The short entry was at $53.80, and the current stop is $55.05. The semiconductors have been lagging the market, and Lam Research is no exception. The stop should be lowered to $54.05. Shares closed at $52.31 Wednesday.
  • Mattel (MAT) - Get Report: The short entry for this one was at $27.75, with a stop at $28.70. The stock is moving lower, so tighten the stop to $27.40 to protect trading capital and lock in a very small gain as a worst-case scenario. Mattel shares closed at $25.92 Wednesday.

At the time of publication, Fitzpatrick held no positions in the stocks mentioned, although holdings can change at any time.

Dan Fitzpatrick is the publisher of

StockMarketMentor.com

, an advisory newsletter and educational forum dedicated to teaching effective risk management and trading methodologies to aspiring traders and investors. He is a former hedge fund manager and a member of the Market Technicians Association, and he now trades from his home in San Diego, Calif. While Fitzpatrick holds various securities licenses, he does not give recommendations to buy or sell stocks. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. He appreciates your feedback;

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