The Best Time To Short Stocks

¹²The Best Time To Short Stocks

[ Normxxx Here:  I am looking to establish a 'short' position (weeks to months) here for what I am expecting will be a brief pullback of less than 20% in the usual time period of September-October-November. Timing and the entry point are critical; but that can be approached by making progressively larger negative bets as the market continues to rise here. Of course, you must be convinced it will eventually go down… After that pullback, I am fully expecting our usual Presidential cycle rise of ~50% from the low of the second year (2010) to the high of the third year (2011). After that… Shorting stocks is NOT simply the obverse of buying them; timing and strategy are essential, and should not be undertaken except by investors/traders experienced in shorting— and with exceptionally good and well tested money management techniques. ]

By Jeff Clark | 2 September 2010

Now THAT was a good, old-fashioned bear spanking.

The short sellers never had a chance. The S&P 500 gapped up 20 points Wednesday morning, never pulled back even one point, and then added 10 more by the close. Anyone who dared to be too aggressive on the short side of the market on Tuesday was tossed overboard on Wednesday. Now they're stuck, flailing their arms in the water and begging for Mr. Market to toss them a life preserver.

Let's hope they're good swimmers. Of course, we knew this was going to happen. The market never rewards the majority. In fact, it does everything possible to inflict the most pain on the popular opinion.

So when last week's American Association of Individual Investors survey reported just over 20% of respondents leaning bullish, we knew the bears were going to get spanked. It has nothing to do with logic. Logic argues we should be bearish. The economy stinks. The world is coming unglued.

The stock market is acting lousy. And we're heading into September and October— traditionally the weakest months of the year for stock prices. It sure seems like the right time to load up on short sales. But here's the problem…

You can't turn on the financial news without hearing some talking head spouting off about the "ominous Hindenburg Omen." One of the most popular videos on YouTube these days is of self-help guru Tony Robbins advising investors to do whatever it takes to protect themselves. Even a quick glance at our own Daily Crux website reveals roughly seven times as many bearish articles as bullish ones.

Logic be damned. It's unwise to short a bunch of stocks when everybody else is doing it. And it's absolutely foolish to short stocks when market conditions are severely oversold— as they were on Monday. The best time to short stocks is when stocks bounce off oversold levels and run into upside resistance.

Take a look at this 60-minute chart of the S&P 500.

The blue lines on the chart represent various resistance levels, and logical spots at which to put on a few short trades. Given the strength of the rally yesterday, it's unlikely the first resistance level at 1,085 is going to hold back the buying. The market should challenge and exceed that level within the next few days. Then, the resistance near 1,100 comes into play.

If the market can rally above 1,100, though, there really isn't anything to keep it from running up to the August high of 1,126. That's 4% higher than where the S&P 500 closed yesterday, and it's enough of a move to shift investor sentiment from bearish back to bullish. Yesterday's big bounce is probably the beginning of a multiple-day rally.

It'll serve to shake some of the overly aggressive bears out of position and get investors talking about the possibility of a "year-end rally." When you start hearing talk like that— especially if it happens with the S&P bumping into the resistance levels— that's when you should start selling stocks short.

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Normxxx    
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