Short Trading Tactics

Here are a few important bits of information you need to know when

you are trading intraday.

1. Intraday trends that move strongly in one direction usually

last 5, 15, 20, and 35 minutes. One intraday trend out of

thirty will last for one hour or more.

2. Gap breakouts of intraday chart patterns tend to move in

the direction of the breakout, lasting on average from 5 to

20 minutes.

3. End-of-day trend tends to continue into the first 10 minutes

of the next trading day.

4. Lower closes and lower lows project the probability of

lower prices 85 to 88 percent of the time. This trend usually

lasts for three days before reversing.

5. Markets and stocks have a three-day cycle.

6. The first 2 hours and the last 2 1/2 hours of the trading day

exhibit the most stable and identifiable trend.

7. Sector rotation may be identified by heavy intraday selling

in the last 45 minutes of the trading day. Weeks later, these

stocks show up on the most-active list.

By studying the following examples, you can focus on the fine

points of shorting overbought stocks. After studying overbought

stocks, we will turn our focus to the second high-probability selection,

which is finding stocks that are at the beginning of or in an

extended bearish trend that is unlikely to reverse for some time.

Figure 5.8 shows a chart of Hewlett-Packard. The bars reflect

daily data over a one-year period of time. Remember, you begin

your search for overbought stocks by using daily price data. Let us

begin our analysis of the chart.

1. The first step is to look at two years of past history for support

and resistance as well as other information that will

give you an idea of the stock's personality. Every stock has

a personality. It reflects the traders who are trading the

stock and what they are likely to do at certain prices. You

will notice that Hewlett-Packard has a habit of putting in

one-day reversals after long runs in trend. When the trend

reverses, the stock falls several points very quickly. These

runs occur after a breakout of price above a 12-day exponential

moving average of the close. After this occurs, one

and a half to two months later, a one-day reversal takes

place at a high. In most cases, just before the one-day reversal

a parabolic run has occurred. (See Chapter 4 to review

parabolic runs and the parabolic rules.)

2. After examining the trend reversals, you note that volume

tends to exhibit spikes at these highs. This is not usually

the case for most stocks, but it is part of Hewlett-Packard's

personality. This information gives you further clues for

establishing a high-probability shorting point on the stock.

3. After plotting several technical indicators, it becomes obvious

that when an RSI (14-day) has a reading of 75, the stock

has a high probability of trending downward to the 12- or

50-day exponential moving average. The Moving Average

Convergence/Divergence (MACD) indicator tends to exhibit

sharp points just before the nine-day trigger line gives a sell

signal.

This stock has all of the necessary components to be a highly

successful stock to short. For the highest probability, you would want

to short only at specific overbought points in time. Even though you

are going to short intraday, these points give you the highest probability

of success. They also exhibit the highest probability for the

microtrend trader to short this stock. In all short-term trading, timing is everything. Shorting is a technique that demands high skill and

superb timing. Before we look further into shorting tactics, let's take a

closer look at Figure 5.8 by examining the information in points 1 to 3.

In Figure 5.9 you will see long trend runs marked by trendlines.

At the end of each of the marked trends you will note a one-day reversal,

which is indicated by a circle around the reversal day. As you

know, this is a bearish signal. When you combine the one-day reversal

Figure 5.9 Two years of history reveal personality

with a parabolic run-up, you have a high probability of trend reversing.

When this trend does reverse, in most cases it will fall to the 12-

day EMA or the first support level. This is important to know because

it is at this point that you might want to cover your short position and

take a profit. Figures 5.10 and 5.11 show a one-year time frame.

In Figure 5.10, you can see the one-day reversal, parabolic runs,

the 12-day EMA, and the 1 1/2 to 2-month trend cycle. Note that when

price closes above the 12-day EMA, trend begins to move and continues

for 1 1/2 to 2 months. The cycle is identified by the numbers at

the bottom of the chart. When you plot moving averages, make sure that you know where the 12-, 20-, and 50-day EMAs are on the chart

in relation to price. This information is of extreme importance

because price tends to rebound from these moving averages a very

high percentage of the time.

In Figure 5.11, note the volume spikes that are circled in the volume

histogram. Volume information is not always a true indicator of

the price trend. Many times, volume will remain flat or below average,

giving no clue as to accumulation or distribution. In this case, Hewlett-

Packard announces its intentions and repeats its behavior over and

over again. Superior traders pay attention to the personality of each

stock they trade—and are usually rewarded for their observations.

high-probability shorting 123

Figure 5.12 shows two technical indicators. Both RSI and MACD

indicate an overbought condition that is ready for a reversal in

trend. When the Relative Strength Index (RSI) has a reading of 75 or

more, the stock is extremely overbought. The arrows identify these

points on the indicator. The standard overbought reading for RSI is

70, identified by the line across the top of the indicator. A reading of

75 exceeds the standard overbought reading, which is the default for

most trading software. I have always found it necessary to plot the

RSI indicator on one year of data for this very reason. By looking at

the data, you can usually find a more accurate overbought reading

based on the price behavior of the stock. In this case, 75 is a more

precise reading and is identified by the number 2 line at the top of

the indicator.

The Moving Average Convergence/Divergence (MACD) indicator

comes to a point just before the nine-day trigger line renders a

sell signal. MACD tends to be a little late with sell signals, but you

need this delay for a true trend to develop. The turning points are

identified by the arrow on the MACD indicator. Other indicators—

CCI (12-day), Bollinger bands, and moving averages—are also used

in your analysis.

All of this information is taken into account when studying the

personality of a specific stock. All stocks have personalities that

can give you a tremendous amount of information to help you

decide whether to buy, sell, or hold, and which strategy would work

best at a given point in time.

You have now identified an overbought stock and highprobability

points at which to go short. Let us begin further analysis

on a microlevel and identify possible intraday behavior of a

stock.

Here are a few important bits of information you need to know when

you are trading intraday.

1. Intraday trends that move strongly in one direction usually

last 5, 15, 20, and 35 minutes. One intraday trend out of

thirty will last for one hour or more.

2. Gap breakouts of intraday chart patterns tend to move in

the direction of the breakout, lasting on average from 5 to

20 minutes.

3. End-of-day trend tends to continue into the first 10 minutes

of the next trading day.

4. Lower closes and lower lows project the probability of

lower prices 85 to 88 percent of the time. This trend usually

lasts for three days before reversing.

5. Markets and stocks have a three-day cycle.

6. The first 2 hours and the last 2 1/2 hours of the trading day

exhibit the most stable and identifiable trend.

7. Sector rotation may be identified by heavy intraday selling

in the last 45 minutes of the trading day. Weeks later, these

stocks show up on the most-active list.

By studying the following examples, you can focus on the fine

points of shorting overbought stocks. After studying overbought

stocks, we will turn our focus to the second high-probability selection,

which is finding stocks that are at the beginning of or in an

extended bearish trend that is unlikely to reverse for some time.

Figure 5.8 shows a chart of Hewlett-Packard. The bars reflect

daily data over a one-year period of time. Remember, you begin

your search for overbought stocks by using daily price data. Let us

begin our analysis of the chart.

1. The first step is to look at two years of past history for support

and resistance as well as other information that will

give you an idea of the stock's personality. Every stock has

a personality. It reflects the traders who are trading the

stock and what they are likely to do at certain prices. You

will notice that Hewlett-Packard has a habit of putting in

one-day reversals after long runs in trend. When the trend

reverses, the stock falls several points very quickly. These

runs occur after a breakout of price above a 12-day exponential

moving average of the close. After this occurs, one

and a half to two months later, a one-day reversal takes

place at a high. In most cases, just before the one-day reversal

a parabolic run has occurred. (See Chapter 4 to review

parabolic runs and the parabolic rules.)

2. After examining the trend reversals, you note that volume

tends to exhibit spikes at these highs. This is not usually

the case for most stocks, but it is part of Hewlett-Packard's

personality. This information gives you further clues for

establishing a high-probability shorting point on the stock.

3. After plotting several technical indicators, it becomes obvious

that when an RSI (14-day) has a reading of 75, the stock

has a high probability of trending downward to the 12- or

50-day exponential moving average. The Moving Average

Convergence/Divergence (MACD) indicator tends to exhibit

sharp points just before the nine-day trigger line gives a sell

signal.

This stock has all of the necessary components to be a highly

successful stock to short. For the highest probability, you would want

to short only at specific overbought points in time. Even though you

are going to short intraday, these points give you the highest probability

of success. They also exhibit the highest probability for the

microtrend trader to short this stock. In all short-term trading, timing is everything. Shorting is a technique that demands high skill and

superb timing. Before we look further into shorting tactics, let's take a

closer look at Figure 5.8 by examining the information in points 1 to 3.

In Figure 5.9 you will see long trend runs marked by trendlines.

At the end of each of the marked trends you will note a one-day reversal,

which is indicated by a circle around the reversal day. As you

know, this is a bearish signal. When you combine the one-day reversal

Figure 5.9 Two years of history reveal personality

with a parabolic run-up, you have a high probability of trend reversing.

When this trend does reverse, in most cases it will fall to the 12-

day EMA or the first support level. This is important to know because

it is at this point that you might want to cover your short position and

take a profit. Figures 5.10 and 5.11 show a one-year time frame.

In Figure 5.10, you can see the one-day reversal, parabolic runs,

the 12-day EMA, and the 1 1/2 to 2-month trend cycle. Note that when

price closes above the 12-day EMA, trend begins to move and continues

for 1 1/2 to 2 months. The cycle is identified by the numbers at

the bottom of the chart. When you plot moving averages, make sure that you know where the 12-, 20-, and 50-day EMAs are on the chart

in relation to price. This information is of extreme importance

because price tends to rebound from these moving averages a very

high percentage of the time.

In Figure 5.11, note the volume spikes that are circled in the volume

histogram. Volume information is not always a true indicator of

the price trend. Many times, volume will remain flat or below average,

giving no clue as to accumulation or distribution. In this case, Hewlett-

Packard announces its intentions and repeats its behavior over and

over again. Superior traders pay attention to the personality of each

stock they trade—and are usually rewarded for their observations.

high-probability shorting 123

Figure 5.12 shows two technical indicators. Both RSI and MACD

indicate an overbought condition that is ready for a reversal in

trend. When the Relative Strength Index (RSI) has a reading of 75 or

more, the stock is extremely overbought. The arrows identify these

points on the indicator. The standard overbought reading for RSI is

70, identified by the line across the top of the indicator. A reading of

75 exceeds the standard overbought reading, which is the default for

most trading software. I have always found it necessary to plot the

RSI indicator on one year of data for this very reason. By looking at

the data, you can usually find a more accurate overbought reading

based on the price behavior of the stock. In this case, 75 is a more

precise reading and is identified by the number 2 line at the top of

the indicator.

The Moving Average Convergence/Divergence (MACD) indicator

comes to a point just before the nine-day trigger line renders a

sell signal. MACD tends to be a little late with sell signals, but you

need this delay for a true trend to develop. The turning points are

identified by the arrow on the MACD indicator. Other indicators—

CCI (12-day), Bollinger bands, and moving averages—are also used

in your analysis.

All of this information is taken into account when studying the

personality of a specific stock. All stocks have personalities that

can give you a tremendous amount of information to help you

decide whether to buy, sell, or hold, and which strategy would work

best at a given point in time.

You have now identified an overbought stock and highprobability

points at which to go short. Let us begin further analysis

on a microlevel and identify possible intraday behavior of a

stock.