On Short Selling/Covering and Respecting the Trend

Within the past couple of weeks, we've seen a dynamic shift in sentiment. Investors and traders are suddenly 'feeling better' about things.

To a certain degree, the drop in oil prices has spurred an orgy of buying in anything unrelated to energy. Perhaps the markets were too oversold and due for a bounce, or perhaps some valuation models kicked in on the low side. Whatever the case, we may have seen the abyss...the armageddon or as my friend Richard Lees once noted, TEOTWAWKI (The End Of The World As We Know It).

Paraphrasing Mark Twain, perhaps the premature death of the US economy has been greatly exaggerated. Whatever the case, the short sellers have been taken to the woodshed, at least temporarily in financial issues. Is this the end of shorting, due to the Fed's most recent proclamation? Hardly so.

The Feds Have Spoken, but Probably Too Little, Too Late

Just two weeks ago, Secretary Paulson, Chairman Bernanke and SEC Chairman Cox announced some sweeping changes regarding financial issues. Namely, the one quirk was about short selling, or naked shortselling. Basically, it is the practice of selling a stock short without first borrowing the shares or ensuring that the shares can be borrowed. Naked shorting is not necessarily a violation of the federal securities laws, and can contribute to market liquidity, but is illegal when it drives down stock prices.

Cox picked out 19 financially-related names that were to be restricted from naked shortselling. Clearly they are playing favorites...why only these names? Could it be they have been targeted by shortsellers for awhile, and for good reason? And if so, why would they pick on these harmless butterflies?

Well, we don't have to re-hash the reasons...suffice it to say there is enough evidence to point in that direction. But this is a mockery of the financial system when it cannot be justified. The free markets are not to be intervened in...rather, let the markets run their course. If banks fail, so be it...they made their bed, now they have to lie in it.

What capital that will ultimately bail out the banks (and cost the taxpayers) is a far cry from solving the problem...much like putting a band-aid on a twelve inch stab wound. So, the shorts have been forced to cover their positions...at somewhat higher prices. Financial names have had a spectacular run, yet are still mostly down for the year...significantly. Yet this 'covering' puts more stock out there on the market, ready for the shorts to pounce on again. That could happen any day.

We Must Respect M...(but we're not talking Mom)

Anyone familiar with William O'Neil of Investor's Business Daily knows the acronym 'CANSLIM'. It stands for various criteria to get into the market and buy stocks. In these initials, the 'M' stands for 'Market'. After all the other criteria are passed, if the Market is not in sync, trades are not made...period. At the end of the day, the market rules and as Mr. O'Neil states clearly, 3 of 4 stocks go down in a bear market...are you good enough to pick the one that doesn't go down..and if so, what's to say that one stock will go up?

In a choppy market such as this one, we'll see some decent movement, but the timeframes are what's important. Trends are established from shifts in sentiment but they take time to develop. Trade when the market is in a clear trend, because buying when the market is taking a nosedive can be hazardous to your wealth.

Disclosure: None

Comments

[omooc:]

Your post is confusing. If your thesis is correct, there would not be 130/30 funds.

2008 Jul 29 08:21 PM

[bizant:]

oil will go more on the downside

2008 Jul 30 11:46 PM