Three Stocks to Short
Good short sales were really tough to find in the broad recovery off the March lows. I understand that "a rising tide lifts all boats" in a bull market, but nearly every stock in my database moved higher during that period. This was unusual and even perplexing because all types of markets, at least until 2009, have generated their fair share of losers.
Many traders blame the
SEC's
temporary ruling to restrict naked shorting for the synthetic feel of the price action. The edict requires that borrowed shares be delivered "promptly," which translates to T+3, or three days after trade execution. In turn, this requirement has forced brokers to reduce their available short lists and call in shares that would otherwise be allowed to float over weeks or months.
Many folks, including myself, wonder if this rule and other stopgaps put in place in 2008 are keeping natural sellers on the sidelines because it's just too much trouble to sell short these days. As a result, we have a market that seems to drift higher after each downdraft, even though buy-side volume is unnaturally weak for this phase of a bull impulse.
The SEC is holding a public roundtable on Sept. 30 to discuss a series of proposals that will affect short-selling practices going forward. The changes could be relatively painless for private traders, like a resumption of the uptick rule, or the process could turn into a witch hunt that damages, perhaps irrevocably, the natural buy-sell structure of the financial markets.
A pre-borrowing requirement will be a major issue discussed at that important meeting. This bureaucratic nightmare would force the trader to go hat in hand and discuss the short sale, in advance, to ensure that available shares are sitting in a drawer at the broker's place of business. OK, that's an exaggeration but you get the idea.
This meeting will also address the industry's reporting requirements, including daily data, transaction information and twice-monthly failure-to-deliver reports, which addresses the notorious naked short-selling issue. Clearly, all the proposals being discussed will make it harder for the small fry to borrow shares, while giving the big boys a number of legal ways to sidestep the rules.
In the meantime, my nightly scans are now pulling up more short-sale patterns than I've seen at any time since the February plunge. This crack-in-the-armor might presage a full-blown correction in September and October. Despite the broker-imposed challenges, these issues could provide the best way to profit in a tough autumn market.
It isn't my style to chase stocks off multiweek highs, so you won't find Tuesday's biggest losers on today's list of short-sale picks. Rather, my strategies focus on issues that failed to participate in the rally in the first place. The forces of gravity could be quite strong in this group, even if the broad market recovers ahead of schedule.
Somebody doesn't like
Sara Lee
( SLE). The stock hit a 17-year low in March and bounced with the broad market. It surged above the 200-day moving average in July, spent five weeks above that level and then sold off sharply. The decline found support around $9 and bounced in a bear flag pattern that stalled at the 50- and 200-day moving averages last week.
The stock is trying to roll over and retest the lows. It shouldn't trade above $10 if this breakdown is legitimate, so that's the logical price to put a stop-loss. In the meantime, zoom into the 60-minute chart and watch for a breakdown from short-term support near $9.55. That could offer the best sell signal to get on board for a decline toward $8.
Utility stocks are showing relative weakness these days, with many industry components rolling over near long-term resistance levels and entering new downtrends.
Hawaiian Electric Industries
(HE) - Get Report
is a case in point after failing to rally above the 200-day moving average in June and then posting a lower high in August.
The stock looks good for a decline into the lower teens, but make sure you understand the added risk of shorting utility stocks. The sector pays out hefty dividends, which the short-seller has to pay if positioned when an issue goes "ex-dividend" each quarter. So keep one eye on the calendar and get to the sidelines when this date approaches. Fortunately, this issue just went ex-dividend on Aug. 20, so it isn't a factor right now.
Targeted short-selling can also work well as a hedge in long-term long-side portfolios. The trick is to find liquid instruments that show relative weakness compared to the broad market and bearish weekly price patterns.
Spartan Stores
(SPTN) - Get Report
fills the bill on both requirements after failing to participate in the five-month rally.
The stock is carving out a series of lower highs, with support at the March low near $11.50. Selling pressure is increasing, raising the odds for another test of that level in the next two to three weeks. Scaling in within the broad pattern might work well, but a better plan is to limit short entries to bounces into trend-line resistance, currently near $14.40.
At the time of publication, Farley had no positions in the stocks mentioned, although holdings can change at any time.
Alan Farley is a private trader and publisher of
Hard Right Edge
, a comprehensive resource for trader education, technical analysis, and short-term trading techniques. He is also the author of
, a premium product that outlines his charts and analysis. Farley has also been featured in
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,
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,
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,
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. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.
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