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How To Profit From Trading In A Weakening Stock Market

Oct. 15, 2014 1:30 PM ETSCHW, CAR
Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

After languishing in "neutral" mode since late September, our proprietary market timing system triggered a fresh "sell" signal to equity swing traders on October 10.

Accordingly, we immediately closed out existing long positions and are no longer to stalking the buy side of the stock market for new trade entries.

Moreover, last week's rule-based shift to "sell" mode, the first in more than six months, means we are now free to begin looking for potential short selling opportunities as well (here is a basic primer on short selling).

While the long-term "buy and hold" investors thrive on strong uptrends in the market, a huge benefit of momentum trend trading when the going gets rough is the ability to profit on both sides of the market (long and short).

Keep on reading to understand why the long side of the market has now become quite risky, as well as to learn a specific chart pattern that will help you find the best stocks to sell short in a weak market (I will even show you a stock that may be actionable for short entry in the coming weeks).

No Support In Times Of Need

In our daily live trading room (included with The Wagner Daily service), we have recently been explaining to subscribers how quickly key technical support levels can become useless when broad market conditions turn ugly.

When a clear market uptrend is in place and market volatility is smooth and steady, a pullback to the 50-day or 200-day moving averages typically presents a low-risk buy entry point in a strong stock.

However, that play goes out the window when the market cracks and volatility picks up.

A great example of just how ineffective major moving averages when the bulls rush to the exit door can be seen on the daily chart of Charles Schwab ($SCHW) below.

Notice how the price crashed through the 200-day moving average, which is typically a "line in the sand" as a long-term indicator of trend:

$SCHW NO SUPPORT

Since roughly 80% of stocks follow the dominant trend of the main stock market indexes, it is a foolish move to search for a diamond in the rough (that's why our timing model exists).

Now that the market has convincingly cracked, US equities could be in trouble for quite some time (but remember that anything can happen in a free market environment).

Consolidation - Why It Can Be Bullish OR Bearish

In uptrending markets, the Morpheus trading system focuses on buying stocks as they break out above bases of consolidation near the highs.

The longer and tighter the price action of a bullish base, the more powerful the upside breakout tends to be.

But even on the short side of the market, we also seek chart patterns that exhibit tight periods of consolidation, albeit only those that form near the lows of a recent decline.

One such bearish pattern forms when a stock suffers a nasty plunge from all-time highs, such as a quick drop of 30%-50% on heavy volume, then consolidates near those lows for 4 to 6 weeks.

When a stock undergoes this type of price action in a weak market, particularly if the stock was a former leader, it often presents a rather profitable opportunity for our subscribers who are prepared to bring home the dosh in both uptrending and downtrending markets.

A great example of the type of breakdown we look for is shown on the weekly chart below:

$CROX breakdown

On the chart above, notice the pattern we are looking for is an ugly selloff, followed by at least a few weeks of price consolidation that stalls at or just above the 40-week moving average (similar to the 200-day moving average on the daily chart).

Not every short selling setup will be as explosive to the downside as $CROX was on the initial drop, but the idea is that the stock should have clearly and convincingly sliced through both its 10-week and 40-week moving averages before finding support.

In the process of doing so, the 40-week moving average subsequently transforms from a paramount support level to a major area of overhead resistance that is tough to push through (especially when the 10-week moving average begins to roll over as well).

Drive This Short Home

Avis Budget Group ($CAR) is an excellent, current example of a stock that has recently suffered a massive breakdown on high volume, and may be in play for potential short entry sometime next month:

$CAR breakdown

After enjoying a 600% run-up since the lows of 2012, $CAR has recently nosedived more than 30% off its highs, while slicing through its 10-week and 40-week moving averages as well.

This stock may be a slower mover than $CROX, but the spirit of the chart pattern is still there.

Although it is still very early in the pattern, $CAR will be in a major jam if it can't get back above 40-week moving average after several weeks of chop.

If that scenario plays out, we will be looking at a possible short sale entry into $CAR, with the expectation of an eventual move back down to the $30-$34 area.

Cash - Still King

If you are nervous about the short side of the market because you are new to trading, that's completely understandable.

If that is the case, I suggest taking some time to learn more about how to short sell stocks, as well as the best patterns to look for when selling short.

But even if you avoid the short side of the market for whatever reason right now, don't forget that cash is always a valid position that enables you to cling to your hard-earned profits when conditions deteriorate.

Now that leading stocks have begun breaking down en masse and our timing model has officially shifted to a "sell" signal, there is simply no reason to be long right now; the risk of being long clearly outweighs any potential reward.

To receive our best stock picks on the short side of the market, including our exact entry, stop, and target prices, subscribe now for your risk-free trial subscription to our nightly swing trading newsletter.

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Original Source

DISCLAIMER: There is a risk for substantial losses trading securities and commodities. This material is for information purposes only and should not be construed as an offer or solicitation of an offer to buy or sell any securities. Morpheus Trading, LLC (hereinafter "The Company") is not a licensed broker, broker-dealer, market maker, investment banker, investment advisor, analyst or underwriter. This discussion contains forward-looking statements that involve risks and uncertainties. A stock's actual results could differ materially from descriptions given. The companies discussed in this report have not approved any statements made by The Company. Please consult a broker or financial planner before purchasing or selling any securities discussed in The Wagner Daily (hereinafter "The Newsletter"). The Company has not been compensated by any of the companies listed herein, or by their affiliates, agents, officers or employees for the preparation and distribution of any materials in The Newsletter. The Company and/or its affiliates, officers, directors and employees may or may not buy, sell or have positions in the securities discussed in The Newsletter and may profit in the event the shares of the companies discussed in The Newsletter rise or fall in value. Past performance never guarantees future results.

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Reproduction without permission is strictly prohibited.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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