Be Ready For A Market Drop With These Stocks

By Cory Mitchell | July 28, 2014 AAA

The overall uptrend in the S&P 500 continues despite light trading volume and regular pullbacks from marginally higher highs. While this isn't a reason to bet against the trend, it's always worthwhile to have a few stocks written down to trade on the short side in case the market does break lower. 

Relative strength, or weakness, is a key component when deciding which stocks to trade. These stocks are already showing relative weakness compared to the S&P 500, which means if the S&P 500 falters these stocks are likely to get hit hard by sellers. No strategy is flawless, but by shorting already weak stocks if the market turns weak, there is some leeway because even if the market doesn't fall much these stocks are already in downtrends that could still continue.

J.P. Morgan Chase & Co. (JPM) has been in a corrective phase since it topped out at $61.48 in March. Since then the price has broken below several prior lows, and while the recent pullback saw some aggressive buying, ultimately the volume was light on the rally and the price is once again moving lower. Recall that the S&P 500 made a higher high in July, so this strong selling in J.P. Morgan shows the stock is considerably weaker than the broader market at this time. On July 8 the stock was down 1.61% compared to the S&P 500 SPDR (SPY) which was down 0.64%. If the stock is this weak currently, it could be hit even harder when the S&P 500 witnesses more sustained declines. 

JPM moved lower

Regions Financial Corp. (RF) also peaked in March at $11.54. The stock rallied in June but ultimately hit stiff resistance just below $11. A potential head and shoulders pattern is also in the making. A short-term drop below $10.40 could trigger a down wave which tests support—and the head and shoulders breakout point—at $9.79. If price breaks below the head and shoulders pattern support level the stock's target is just above $8. From a long-term and short-term perspective the price action shows relative weakness compared to the S&P 500. The stock sold off 1.86% on July 8, relative to the 0.64% S&P 500 SPDR decline. 

RF head and shoulder pattern

ING Group (ING), another financial sector stock, also sold off more than the S&P 500 on July 8. This stock hasn't been able to make headway higher since mid-January. It is moving between resistance near $14.80 and support near $12.90. After testing resistance in June and early July, and failing to break above it, the most likely course for the price to take is back toward support. A long-term break of support could take the price to $11.

ING moved between resistance and support

Pentair PLC (PNR) peaked in March at $83.37, and has been sliding since. In late June and July the decline has seen rising volume, as the price broke below the neckline ($72.40) of a complex head and shoulders pattern. The overall lower highs since March show buyers are unwilling to step up and accumulate the stock, and sellers are eager to get out. The head and shoulders pattern provides a target of roughly $62. July 8 also saw the stock decline more than S&P 500, showing that the relative weakness is still in force.

PNR broke neckline

The Bottom Line

Trading against a major uptrend like what the S&P 500 is in isn't always wise, yet having a few stocks to trade on S&P 500 down days/weeks is just good planning. These stocks are already in downtrends, so trading the short side is the more favorable play than trying to buy via bottom picking. Also, the down days in these stocks are typically greater (in terms of percentage moves) than corresponding S&P 500 down days, which means greater profit potential if on the right side of the trade. The goal is not to exclude long trades and participate in the broader market uptrend, but to simply provide some trading alternatives and swing trading diversification when the S&P 500 is weak.

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