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.