A Trader’s Guide to Cross Training

by MoleFebruary 10, 2010

This is part I of a new series I’ll be drumming regarding selling individual stocks short. Up first for discussion – The Black Cross.

I know a lot of you trade mostly indices (nothing wrong with that). While I monitor market indices continuously, I trade more in individual names (nothing so wrong so far). In this series we’re going to use the indices from time to time, but mainly we’re hunting for individual Red Octobers.

First, I’m not interested in taking shots at up-trending stocks which appear over-valued (Barron’s can have at all of those) and certainly I’m not shorting something because it is over-bought. If you don’t know by now, the latter is an especially dedicatated method of intermittent suicide.

I want to live!

Very good. So indices will be relevant as to how, when and what individual names to sell short, but the meat of the matter will regard which set-ups to fire at and where lie the entries which have the best chance of success, the optimal risk vs. reward; little details like that.

Most certainly, there’s thrill in the kill – not exactly news to the bloodthirsty, decay-seeking vultures here. But let’s be honest, all of us could stand to improve on how to harpoon a duck. Swinging for the fences on a name coming off its high is all well and good (if you’re looking to lose more than you win, only to pump your fist like a pathetic amateur when you finally bag 5 points in a hurry on some overbought POS!). There are better entries than that.

Enter the Black Cross. The Black Cross occurs when a 50-day moving average (MA), which is trending to the downside, crosses the 200-day MA, which at this point is still rising.

Obviously, it requires a downtrend before this can occur, so by definition it is not swinging for the fences on a stock which just made a new high. In fact, the optimal point to sell short a name is actually some 4 to 6 months after the stock has peaked (especially a former leader from a previous bull market). Sure, you are selling at a lower price, but you did not get beat up on the leaders which manage to keep leading (in spite of what you thought). By waiting this period of time, you’ve ground down the lingering bullishness of a major winner coming off highs (since there are plenty of fund managers who wouldn’t buy a GS when it was going straight up, but they will justify buying it on the way down, having just seen how high the beast can actually print. Extreme moves make an impression and the psyche is somehow more comfortable here vs. moving only-higher. This point is backed up by fund data as well, which show that more funds own the biggest historical winners after they have fallen more than 50% than ever did during their big run higher). You’re selling at a lower price, but the trend is now well established, there is a major amount of supply now overhead (which means it is not going to have the previous up-only action as it had before the peak) and the likelihood that the stock drops from here is maximized; if you’re in a correction or a bear market, then consider it more likely than not.

Getting in a little ahead of the cross is not a bad idea, assuming the trend is clearly established, the group is a laggard and the cross is very likely imminent. Another reason being a little early is not necessarily bad is that you’re not going to be the only guy carrying a cannon when this technical transpires. If we can establish the market is in a correction, then shorting strength against names within a lagging, liquid group when the Black Cross is imminent, is not the worst entry in the world.

After the cross, the issue is not always straight down, so be prepared for potentially wicked counter moves. It is an art to know which moves to fade and which to tuck your tail and run, but in general the weakest groups in a general market correction are going to have big one-day wonder-rushes higher and fail immediately or else very soon after. An extended rally of two or three days on heavy volume means you are fighting now, some kind of new trend you do not understand. At this point you take your lumps and wait for better; coming back in again lower is no sin, since you’re firing at wounded animals (my kind of fight); the sin is continuing to take shots higher and higher. Fade the 1-day-wonder rallies, but be ready to turn tail when they don’t re-establish their trend downward.

Further, in terms of trading gains we’re really looking for 10-20% kills in this type of set-up. I’ll acknowledge that you can re-set several times, depending on opportunity, speed and grace, but I’m covering panics, big down-gaps, etc., while holding longer if a name is only drip drip dripping lower (the latter are better for getting to 20% because you can drip lower for some time before the gap or panic-slice occurs; cover then). If I am attacking into expected news, such as an earnings report at a time when most companies reporting are getting hit (another tactic we’ll cover in this series) I might do better than the 20%, especially if it is a less liquid stock, but understand we are risking more in that situation at the same time.

Before we get to the (ugly) charts below, let’s list the desired elements for attacking the Black Cross…

-Liquid stocks are preferable (easier to trade; less likely to gap significantly higher or be bought-out by a larger company; greater supply overhead making it more difficult to digest than a thin name; more pros are shorting along with you, adding to the selling spirits/trend).
-Former big winners from the previous bull market, 4-to-6 months from their peak, present the optimal Black Cross candidates for selling short.
-A modest 10-20% is the objective and you cover (I like covering a panic-day by the end of that session, or else the open of the following day, regardless of my percentage gain; I’m looking to grind-out longer and lower if the name is dropping steadily + modestly).
-As always, benchmarks for stop-loss are a must (while you don’t want to be shaken out of the 1-day-wonder counter-moves, since those are actually good entries, you do need to cover and protect if the name manages more than a couple of days uptrend on strong volume; we’re after easy money here – if you’re sweating then you’re more likely in the wrong place).

I’ve got more rough text I may come in with later, but for now here is a small slew of before, during and after Black Cross samples. These are each liquid, money-center banks (a consistently lagging group since the current market correction began). In the case of MS (Morgan Stanley), the Black Cross is occurring right now; GS (Goldman Sachs) and DB (Deutsche Bank) look imminent; and UBS crossed at the beginning of the month. These are daily charts, intraday from early today – I may come in and change update these to closing prices after the close.

**Finally, as always, don’t do what I do. Anything you attempt is your own problem. I’m only illustrating a strategy that has worked (and failed) in the past. If you are trading options, I really can’t advise you (premium since the VIX increase make options a more difficult play here, along with the ever-present difficult spreads). Also, I am not expert in options and my super-computer still fits on my one desk, so my opinion is mediocre at best. Targets on these names is not worth asking me about either, although I’m willing to discuss stop-loss benchmarks. The reason I’m down on the targets is those are very fluid for me – it depends on the general market, the degree of panic (or not), technical levels, and so much more. In general if I am short and there is an emotional slice down in a name, then I am at least trimming that position. That’s enough talk…Beast out!

The Black Cross – before, before, during and after. 200-day MA is the black line; 50-day MA is in red. Click to enlarge…

DB^^

GS^^

MS^^ (crossing now)

UBS^^

About The Author

Mole

Mole created Evil Speculator amidst the chaos of the financial crisis in early August of 2008. His vision for Evil Speculator is a refuge of reason, hands-on trading knowledge, and inspiration for traders of all ages and stripes. You can follow him and his nefarious schemes at various social media waterholes below.