The major indices have dropped a long way since mid-May, but it still isn't too late to sell short. Many of the sectors that held up well in the last month are now rolling over and joining their weaker cousins in notable declines. So get in there and take the short-sale plunge so you don't get left out while the market is rewarding this classic strategy.

Momentum short-selling is the most popular method to play falling markets, but it's also the easiest way to lose money. In this approach, traders sell stocks that are dropping at a rapid pace and hope they don't get caught in inevitable short squeezes. These fast-moving positions can offer great profits but are very hard to time perfectly.

This is related to the dangers of "short overcrowding." Simply stated, many traders notice that a stock is falling hard, and they mindlessly jump on board. Sooner or later, that side of the market gets filled to the brim with weak-handed players trying to grab the low-hanging fruit.

These short-sellers create buying power because they're nervous nellies -- easy to shake out. Contrarians see the telltale signs of short overcrowding and target those markets in an effort to force the crowd into a covering panic. It's no different than a few cows in a big herd getting freaked out and starting a massive stampede.

So tread lightly when looking for new short sales, and focus on stocks that show the characteristics of impending declines, rather than ones already stuck in big downtrends. There's less competition, and you'll be covering your trades for decent profits just as the crowd notices the selloff and starts to chase it into yet another overcrowding scenario.

iShares Russell 2000 Index Fund ETF (IWM)
Click here for larger image.
Source: eSignal

The iShares Russell 2000 Index Fund ( IWM) ETF spiked up to a three-month high at $63.25 in early June, rising above 200-day moving average resistance. It held above that level for three sessions and then sold off into the late-May swing low. The next uptick stalled at the 200-day barrier and gave way to another downturn.

This rollover has completed a bearish head-and-shoulders topping pattern, with the neckline at $71.50. A break at that support level should trigger a major decline that eventually fills the April 15 gap at $69. Longer term, this instrument looks like its gearing up a critical test at the March low.


Annaly Capital Management (NLY)
Click here for larger image.
Source: eSignal

Annaly Capital Management ( NLY) plunged from $21.20 to $11.50 in just three weeks before bouncing with the broad market in March. Price then jumped quickly back to $17.52 and ground sideways in a choppy pattern before topping out in May just 51 cents above the late-March peak.

The stock broke two-month support earlier this month and has been pulling back to test resistance for the last two weeks. It's made little progress, while selling pressure under the surface has picked up. This is the perfect prescription for a follow-through selloff that drops the stock through the swing lows at $15.25 and into a test of first-quarter support.


Automatic Data Processing (ADP)
Click here for larger image.
Source: eSignal

Automatic Data Processing ( ADP) rallied to a recovery high at $49.81 in October and dropped 12 points into the January low. It then bounced weakly and tested that level for the next two months before embarking on a stronger recovery attempt. That uptrend stalled in early April at 50- and 200-day moving average resistance.

The stock has been moving sideways since that time in a head-and-shoulders topping pattern that will complete when price finally drops into the neckline, currently at $41.50. A break at that support level should trigger a substantial selloff that eventually tests first-quarter support in the mid-$30s.


Invesco (IVZ)
Click here for larger image.
Source: eSignal

Invesco ( IVZ) rallied to a seven-year high in December and sold off with the broad market. It bottomed out in March and shot back to 50- and 200-day moving average resistance. The stock surged above those levels in early May and reached $29, but then the move stalled once again. It's been pulling back in a slow decline since then.

Price dropped into the 200-day moving average last week and has been congesting into an ominous narrow range pattern at this level for the last four price bars. A break at $25.70 would confirm a breakdown and support an active downtrend that shows little support until the April swing lows at $22.


Belden (BDC)
Click here for larger image.
Source: eSignal

Belden ( BDC) topped out near $60 in 2007 after a multiyear uptrend. It dropped hard at that level and has been caught in a major decline for the last 11 months. The stock hit a deep low in April and bounced about six weeks later to 200-day moving average resistance, where the recovery effort failed.

Price surged below the 50-day moving average two weeks ago and has bounced back to test this new barrier. A breakdown under the eight-day low at $35.77 should issue a renewed sell signal for a virulent decline. The next support near $33 should stall but not stop the downside, which might carry price into a test of the April low near $30.28.


With a market this tumultuous, there's always a stock falling fast, but wait for the right signals before shorting. You don't want to be a victim of yet another volatile squeeze.

Alan Farley provides daily stock picks and commentary with his "Daily Swing Trade" newsletter.

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

Farley is also the author of The Daily Swing Trade, a premium product that outlines his charts and analysis. Farley has also been featured in Barron's, SmartMoney, Tech Week, Active Trader, MoneyCentral, Technical Investor, Bridge Trader and Online Investor. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.

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