Brick and mortar retailers have been sold relentlessly in the last few months, succumbing to reports that hedge funds have taken significant short positions in anticipation of bankruptcies. Despite the bearish wave, sector indices continue to hold long-term support while relative strength readings approach deeply oversold levels. This potent combination could generate a short squeeze that wipes out overconfident sellers and brings the beaten-down group back into equilibrium.

Department stores have taken the biggest hits since a mild recovery wave fizzled out in February, with the main players descending to 2017 lows. While a squeeze isn’t likely to alter the bearish technical tone, these issues should offer the greatest upside because they’ve attracted the highest short interest. Even so, anticipating upside catalysts will be challenging because these mall anchors aren’t scheduled to report earnings until mid-May.

XRT

The SPDR S&P Retail ETF (XRT) returned to the 2007 high at $22.75 in 2010 and broke out into 2011, gaining ground in a powerful trend advance that continued into the 2015 all-time high at $51.25. It sold off to the 200-week EMA in the first quarter of 2016 and bounce in a recovery wave that stalled in the mid-40s. The fund has tested moving average support four more times, with the current test now in its seventh week.

This resilient price action on top of long-term support should generate a buying wave that squeezes short sellers for many weeks. The upper-40s looks like a logical reward target that reaches the yearlong rising trendline and tests resistance at 2015 high. Multi-week positions taken in anticipation of this upsurge should place trailing stops because a breakout is unlikely, given the power of the secular downtrend.

KSS

Kohl's, Corp. (KSS) tested 2002 resistance in the mid-70s in 2007 and again in 2015, with aggressive sellers hitting the bids and taking control both times. The most recent downturn found support in the low-30s in May 2016, ahead of a recovery wave that stalled near $60 in December. A selloff into 2017 posted a bearish island reversal, establishing a new resistance zone between $44 and $50.

The stock fell to a 7-month low in March and is now grinding sideways just below the 50-day EMA at 40. A breakout above this intermediate resistance level could set a short squeeze into motion, with a gap fill offering an aggressive profit target near $50 (blue line). The 200-day EMA falling through the low-40s could act as a final barrier, ahead of more vertical advance. The company reports earnings on May 11.

esignal.com

Nordstrom, Inc. (JWN) broke out above the 2007 high at $59.70 in 2014 and rallied to an all-time high at $83.16 in March 2015. It then turned sharply lower, dumping in a vertical decline that posted a 5-year low in the low-30s in June 2016. A bounce into November ran into a buzzsaw of selling pressure at the 200-week EMA, generating a reversal that continued to post lows into late March.

The recent upturn from $40 could mark a higher low in the broad pattern and yield a short squeeze that eventually tests the long-term moving average in the upper-50s. Range resistance marked by the January gap between $45 and $48 (blue line) looks like the trigger point, with a breakout above that price zone forcing short sellers to cover positions in a positive feedback loop that reaches the upside target.

The Bottom Line

Selling pressure in the retail sector may have run its course, setting the stage for a multi-week short squeeze that returns equilibrium to this lopsidedly negative market group. However, risk remains high because rallies should eventually attract strong-hand sellers so it makes sense to place tight trailing stops to protect intermediate profits.

<Disclosure: the author held no positions in aforementioned stocks at the time of publication.>

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