Why We Went Short POT

Last week was fantastic for the bulls as markets soared worldwide. The Dow moved 7.3% higher, London's FTSE 100 rallied 6.3%, and Brazil's Bovespa was 5.8% higher. As mentioned in last week's issue of my weekly newsletter EPIC Insights, such synchronized markets are great if you are on the right side, but they make for difficult trading environments for those who prefer to remain hedged.

After the powerful move, our goal is to determine what will occur next. Examining a variety of charts, we receive mixed messages. While some companies show gaps higher that should lead to steadily increasing stock prices, others have only retraced a portion of their recent losses and remain in well-defined downtrends.

To highlight this difference, we will look at the charts of two different companies - IBM and Potash (POT). IBM is an example of strength. The stock increased 14.5% during the week as a better than expected forecast allowed the shares to leap higher. Prior to this announcement, IBM was already strong. A steady uptrend (blue line) since December has allowed the shares to continuously move higher. Last week, a gap higher (black circle) occurred after earnings on increasing volume (green arrow), which should offer support to any future decline.

click to enlarge

Contrast IBM with a current short position in our portfolio, POT. POT had a strong week as the shares moved 7.3% higher. However, this rally was not a show of strength, but an oversold bounce in a continued bearish pattern. A short-term chart illustrates that while the stock bounced off the 50% retracement level (black arrow) it still remains below the 33% retracement point. Further, the price is below long-term resistance of $94. The inability of POT to benefit from rallying markets and move through resistance indicates the rally is nothing more than an oversold bounce that will stall.

This assessment leads us to our next move. Currently, the short of POT is 2% of the total portfolio. If the price moves higher, we will use $94 as a stop-loss, thus presenting a potential loss of 3%. However, if our prediction of lower prices is correct the shares should retest the 50% retracement level of $83.50 and provide a return of 8.5%. With the risk-reward skewed in our favor, I recommend adding to the short position in POT as this week's technical trade. Use a close above $94 as a stop-loss.

Comments

[ScroogeMcduck:]

Sean i must admit i had my doughts on your V short trade 4 weeks ago and it looks like it worked out quite well for you.
I will pay much more attention to your trades in the future. Keep them comming.

P.S. what was your gain on Shorting V?

Jul 21 03:17 PM

[WACG:]

Technical "Analysis" is EXACTLY like trying to drive a car by looking in the rearview mirror. Those that "invest" using such cloud pattern interpretations will lose money the same way. Shorting because of the truly imaginary patterns in price charts is doubly stupid because the risk is, in principle, unlimited. But have fun kid. It ain't my money.

Jul 22 09:03 AM

[LoveShorting:]

good, educational piece, thanks.

Jul 22 10:27 AM

[frugalandpu...:]

If you were to do a "blind" TA test, and give people charts from the past, and ask them to guess where it headed, they would be wrong 50% of the time. Anyone who uses TA is a joke.

Jul 22 10:58 AM

[DynastyMgr:]

Well you took a 3% loss on your POT short trade today with POT hitting a high of $97.60 (assuming you got out at $94). I must admit, I was surprised to see the stock pop after reporting worse than expected earnings. Nothing has made sense on this market for the past year. Good news for me though as I am long POT, MOS, IPI & TRA.

Jul 23 03:18 PM

[Rahul Rai:]

Yes, i knoe they did canpotex deal but it doesnt make sense that POT went up so much. Market is not making sense

Jul 23 03:24 PM