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A Trader’s Guide to Individual Shorts – Part II

by MoleMarch 2, 2010

GS Setups Short (off the October 2009 top)

Since the cat is away, the rats will play. I haven’t seen Mole’s name on the AP wire, so I assume he’s having a great time in the desert.

Like always, nothing I post is a recommendation. Think of this post as a demonstration.

If I can roughly define my potential loss and I consider my potential gain to be twice, thrice or better than the loss, I’ll flip a coin even against the wind to take that trade. And while the better entry occurred in January, a decent door-prize set-up exists now with bellwether Goldman Sachs (GS).

Since I don’t have a lot of time (ever the case these days, sorry), I’m going to just spit out my thinking. First, a mainly O’Neilian way of looking at attacking shorts:

-Big winners in a bull cycle often present the best short selling opportunities in the ensuing bear cycle. But…
-Look first for a break off the top, occurring on major volume, and then wait wait wait.
-Waiting 3-6 months for the optimal entry significantly increases ones positive expectation value (bullish sentiment will usually prevail for some time off the top, since investors and fund managers are psychologically fixated on the previous highs. Many refused buying on the way up, but are “comfortable” now to take positions on the way down. Meanwhile if the stock is indeed going to be a great short candidate, we’ll see clear distribution during this period ((selling on large volume, buying on smaller volume)) as the supply of stock is transferred to newer hands; hands who have a higher cost-basis, making overhead supply more relevant).
-If the stock manages higher-highs after this correction, then being patient saved getting beaten up shorting too soon (a famously common mistake, especially all the way up).
-Look for a break of the 50-day (on major volume) and then 3-to-4 rallies temporarily back above that (now downward trending) 50-day level.

Let’s look at the optimal set-up of GS, which occurred January 21st, the morning of their quarterly earnings report:

Click to enlarge and then click again ^^

-GS had broken-down off the top on October 15th on heavy, rising volume.
-Read above why 3-6 months is optimal for attacking a former leader short.
-GS rallied above the 50-day for the 4th time on January 21st, THIS WAS THE OPTIMAL MOMENT TO SHORT GS (169-171 on the morning of the 21st).
-Head and shoulders neckline is broken later on the January 21st session.

Let’s look at the Door-prize entry for GS now today:

-While GS has consolidated some lately, everything above still applies and GS is now at potential strong resistance, making it a fresh set-up short on any stab at the 50-day.
-The 50-day on GS has crossed the 200-day – the Black Cross is in affect.
-Using the 50 or 200-day moving averages (on a closing basis) provides a good, tight stop, since we know the stock should fail at or about this level if the name is to remain a winning short.
-Tuesday’s high (today, March 2nd) was 159.75 and the 50-day is trending lower, now ~160.70 (close enough to enter short in my book, since a failure of the test of the 50-day can come before the stock reaches the level).
-A close** above 161 on rising volume would indicate being stopped-out in my book; while any close above the 200-day would equate to the same, regardless of volume (GS 200-day is currently 163.10 and slowly rising).
-Thus, I’m looking at 4 or 5 points of risk to attack a name which should test previous lows or perhaps better, following a return to the trend lower.
-I’m not saying GS tests its lows now (or better) – I’m demonstrating that I can risk less than I stand to gain for something I’ve decided is more likely to happen than not.

**A note about closing basis – I will blow-out a position before the close if volume is strong enough and well before the close if volume is extreme (>2x’s normal for large-cap and >4x’s for smaller-cap). Otherwise, I am looking at the close, if it is going to be close, or the final hour of the session if it is clearly above my benchmark.

Hope that’s helpful. Good trading!

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.