With the broad market at overbought levels and the major indices testing resistance, it's the right time to check out new short sales. However, traders need to avoid the most costly rookie mistake when selling short after a big rally and forgo positions in strong stocks that are pulling back for the first time.

Instead, save your firepower for weak issues that failed to participate when the rising seas were lifting all boats. The theory here is simple -- these laggards should fall under their own weight when selling pressure returns to the market. With this in mind, I'd avoid short sales in tech, retail or the financial sectors.

That will change if these leadership groups grind out lower highs that signal waning momentum and vulnerability to a larger-scale decline. Just keep in mind this topping process can take considerable time, as we saw after the post- Bear Stearns rally in the spring of 2008. The best short sales after that uptrend didn't show up until June and August.

In the meantime, two sectors stand out like sore thumbs as nonparticipants in the March-into-April rally, biotechs and agriculture stocks. These two groups look extra heavy now and could spiral into steep declines at any time. That makes them perfect candidates for short-selling while the market works off its overbought technical condition.


PowerShares DB Agriculture ETF (DBA) -- Daily
eSignal

The PowerShares DB Agriculture ( DBA) ETF sold off from $43.50 to $21.50 last year and then bounced into January. That recovery marked the high for 2009, with the fund grinding lower since that time in a lazy decline. It's now probing a seven-week low, and despite upbeat accumulation appears headed into a test of its bear-market low.

Rather than sell short the fund directly, look at components that show more favorable reward-to-risk profiles. These include Monsanto ( MON), Compass Minerals ( CMP) and Archer Daniels Midland ( ADM). I'd avoid sector stocks involved in takeover and acquisition activity, like Agrium ( AGU), CF Industries ( CF) and Terra Industries ( TRA).

Archer Daniels Midland (ADM) -- Daily
eSignal

Archer Daniels Midland in particular looks like a promising short sale after its three-month battle at the 200-day moving average. The stock hit that resistance in December and now shows eight failed tests at this formidable barrier. Downside momentum is accelerating, with price dropping toward key support at the January swing low.

A breakdown from that level should trigger a decline that drops the stock toward its bear-market low at $13.53. Notably, this is a relatively slow mover in the agricultural group, so a downtrend might take several months to unfold. That makes this issue an interesting choice as a short hedge in a long-weighted portfolio.


Biotechs ran into a brick wall when the Obama administration tackled health care reform in February. However, the sector's misfortune began even earlier, when these issues failed to take advantage of a leadership role after the 2008 crash. Fresh January capital had offered a perfect opportunity to lift the sector, which held up well in the fourth quarter.

SPDR Biotech ETF (XBI) -- Daily
eSignal

Biotechs ground sideways through January, making no headway, and then plunged after the government news. They bounced with the market in March but have underperformed badly in the last seven weeks. Selling pressure has increased considerably since the start of April, with the SPDR Biotech ( XBI) ETF now testing its 2009 low.

Note how the March low aligns with November's bear-market low. This is bad news, because the most recent downswing has completed an inverse cup-and-handle breakdown pattern. A major sell signal will trigger on a decline through support at $43. The ensuing downtrend should drop price though the fund's historic low at $41.77 and into the $30s.

Big-cap biotechs show the most promising short-sale patterns. On the other hand, it's best to avoid sector small caps because bullish stories like Dendreon's ( DNDN) will still attract aggressive speculators. With this caution in mind, the top short prospects at this time are Amgen ( AMGN), Cephalon ( CEPH) and Genzyme ( GENZ).

Genzyme (GENZ) -- Daily
eSignal

Genzyme is an especially interesting short play because the selloff into March broke 2006 support at $54.64. The seven-week recovery lifted price over that key level, but the uptick stalled well under the 50-day moving average at the end of March, with the stock rolling over and testing that level once again.

Frankly, there's no reason this issue should stop falling right here. The technicals show heavy distribution, which points to funds and institutions dumping positions as quickly as they can. This lack of sponsorship could set up a major gravity wave that carries price through the 2009 low and down to 2004 support in the low $40s.


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.

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 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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