I know from experience and
from reviewing many of the questions I
get from TradingMarkets.com subscribers that many of
you following my commentary and techniques have not
been using our short-sale criteria diligently or
properly. Investors should realize that so far this
year our short-hedges have contributed half of our
total profit -- and if we get new lows in the Nasdaq,
Dow and S&P, I would expect shorts to make up the
vast majority of our profits this year. For this
reason, I want to review the criteria listed in my
book with regards to short sales. I also want to cover how we adjust this
strategy if a real bear market appears so that
TradingMarkets.com subscribers are ready and able to
pounce on the fast profits that shorts in a bear
market can create.
Each week I comment on all
stocks that meet our upfuel criteria and have broken
out of valid 4+ week flags or cup-and-handles, as
well as all stock that meet our downfuel criteria and
have broken down out of valid 4+ week down-flags and
down cup-and-handles. Let's review those criteria,
which we use in all market environments. If you also
need to review how we use breakouts to determine
exact entry and exit, please review my 10-week
trading course, free and available to all
TradingMarkets.com subscribers. You may also want to
review my book or Science of Trading courses,
available via M. Gordon Publishing through
TradingMarkets.com, to become more expert at
implementing this strategy.
Criteria for finding
short-sales with minimum downfuel:
1. Earnings:
Either: (a) a decline in annual
earnings and an estimate of either an annual loss
or another decline in annual earnings, plus two
down quarterly earnings or two negative quarterly
earnings;
or
(b) two quarterly
earnings down 40% or more, or two negative
quarterly earnings with acceleration in the
decline; finally if either criteria "a"
or "b" are met, the stock remains a
short-sale candidate from an earnings criteria
standpoint as long as quarterly earnings continue
to be lower than year earlier quarters or
continue negative. (For maximum fuel, either the
above are met or a stock has two quarters in a
row of declining earnings and declining sales,
and a price/sales ratio (P/S) >10 and
PE>S&P's PE.)
2. Runaway technical market
characteristics down are displayed on the daily or
weekly chart.
3. EPS and RS rank both < 50.
4. Yield 5% or <. (For
maximum fuel must = 0.)
5. Debt -- must have some,
the more the better, over 100% ideal.(Max.
Fuel >99.)
6. Funds -- must have some
institutional ownership, >30% is optimum.
(Max.
Fuel >20.)
7. The worst or
second-to-worst rating by Value Line, Zachs, or
Lowry's rating services.
8. (Max.
fuel only -- must be a clear bear market in stocks if
stock is related to market -- according to Chartist,
BCA, bond/bill/index rules, or PSL systems.)
9.(Max.
fuel only -- forming or formed weekly or monthly
pattern of Double Top, failed rally, or
Head-and-Shoulders Top and P/S > 10.)
This allows us considerably
more flexibility to adjust our portfolio to the U.S.
market. We can create a fully hedged fund -- or
adjust our short positions to offset as much of our
long U.S. exposure as the market environment
dictates. As Julian Robertson said, "Our goal is
to own the best companies and be short the worst
companies."
Over the last decade, our short
criteria have helped us to:
1) determine when the
U.S. market is starting to weaken as these stocks
usually begin to accelerate down just before a broad
market;
2) effectively hedge a broad decline as
these stocks tend to under-perform our longs and the
market during corrections in particular;
3) profit
from a bear market, rather than be chewed up by it;
4) clean-up from a two-way market environment where
some stocks are still moving up or down and others
are moving consistently in the opposite direction, as
usually develops during transition periods when the
major trend is changing; and
5) get advance notice of
when serious changes in the market are occurring (as
we were able to take 1/3 profits on everything in
early March of this year) because we're watching the
action of both the weakest and strongest stocks in
terms of their respective trends.
Thus, while
we do not recommend a fully hedged portfolio at all
times, we do recommend covering part or all of your
long exposure via shorts during times when the
interest-rate environment is neutral - negative, when
the U.S. technicals are poor, or when overvaluation
is extreme enough that systemic market risk is
unusually high, but an all-out bearish signal has not
yet been given. Only when the U.S. and most global
markets have generated universal bearish signals,
would we become net short as part of our allocation
strategy.
Like our longs, investors
should use flag-down breakdowns of 4 weeks or more
and valid cup-and-handle down breakdowns of 4 weeks
or more as signals of when and where to short stocks
meeting the above criteria. As you get more
proficient at locating stocks that meet this criteria
and then looking only for trades in stocks meeting
these criteria and also breakdown out of valid
patterns, you can refer to my weekly commentary to
confirm that we're finding exactly the same stocks
and that you're following the technique properly. In
fact, that's what my weekly
commentary is for -- it's designed to help those
trying to utilize this specific technique to trade
the markets. Many investors at
first had questions as to why a stock they thought
met the criteria wasn't included -- but as I've
answered these questions over time most
investors following this technique for many months
studiously now understand that I am commenting on
absolutely every stock that meets these rigid
criteria and that an investor working hard on
following this technique can have very nearly
identical results as the ones reported in my weekly
column.Over the first
year-and-a-quarter or so, most criticism and
commentary have come from traders who have not
thoroughly studied my courses and this technique. So
far, at least, I have not yet heard from or met a
trader who has tried diligently to follow this
methodology religiously who has not been very happy
with his/her trading results.
We basically exit short
stocks on:
1) Positive turnaround in
earnings;
2) whenever their PE gets below their
expected growth rate;
3) whenever they violate their
200 MA by 10% or more;
4) take half profits on 40%
decline from entry and then begin using any high with
six lower highs surrounding it as trailing stop;
5)
on every new low use ops above correction high as
trailing stop;
6) exit if Relative Strength rank or
EPS rank ever move above 50 from below it;
7) on any
weekly chart double bottom or head-and-shoulders
bottom;
8) whenever the stock reacts positively to
what should clearly be negative news, or on positive
reaction to restructuring or new management.
Although the odds are now
tilting toward the current (5/00) environment being a
bear market, I am not solidly convinced that we are
there yet. It would take new closing lows in the
Nasdaq, S&P and Dow below their respective
February-March lows before I will be fully convinced
that we are in another leg down of an ongoing bear
market. I would also like to see at least a week of
consistent 20+ number of stocks on our Bottom RS/EPS
New Lows list, and a much higher concentration of
valid breakdowns in stocks on these new lows list.
Similarly, I would like to see a large concentration
of specific industries dominate the new lows lists.
If we get all these factors coming together, than for
the first time since 1994, investors will need to
look for and allocate more capital to short selling.
The above
"downfuel" criteria for finding
short-hedges is valid in a bear market, as in a bull
or sideways one. However, to maximize profit in a
bear market (assuming all of the bear market factors
mentioned above come to pass), traders should also
look for major topping patterns in former leaders
running out of gas, for about half of their
short-sale exposure. As we get more of these patterns
and more of our typical short-hedge exposure,
investors should add about 7% of capital per new
short trade and stop at about 24 positions. You
basically let the market determine the number of
shorts and longs by how many valid breakouts or
breakdowns you get. Hold back on adding more than two
new positions short or two new positions long in any
one week. Theoretically, you could get to be 200%
long or 200% short in an extremely strong or weak
market. To find former leaders running out of bas,
get our your Daily Graphs booklets or look at a huge
number of stocks on a weekly-chart basis. Screen for
stocks that are forming six month+ topping patterns
such as Double Tops, Triple Tops, and
Head-and-Shoulders Tops over a very long period of
time. From this list of potential topping pattern
stocks, look for over-valued equities with a P/S >
3 (ideally >10) and with a P/E much greater than
the last year's earnings growth and much greater than
the next year's projected earnings growth. Next, from
this smaller list of potential shorts, look for
stocks where earnings growth rates are slowing down.
The big money is made shorting major chart breakdowns
in stocks where expectations have been out of line
with reality, that are starting to disappoint
investors that held those out-of-line expectations.
Only look for these stocks when you are very sure
that we're in a bear market. We'll try to point out
some such issues as examples, should we become
convinced that a real bear market is in progress, in
our weekly commentary in the weeks and months ahead.
Most traders have only looked
at our long-side upfuel criteria and buy rules. Now
is the time to review our short-hedge strategies and
our aggressive short rules for bear markets. By using
these strategies along with our long-side rules,
investors can achieve smoother long-term returns,
higher long-term gains, and more consistent profits
in their stock trading accounts.
