The "trend is your friend" is one of the most common trading axioms in existence. What it means is that more often than not, the underlying primary trend tends to remain in motion despite several counter trend moves that occur on shorter time frames. Traders looking for high probability setups are often better served trading in the same direction as the primary trend. The trend has clearly been lower in the markets over the past few months, and shorting after bounces has been a viable strategy. With the markets attempting to rally over the past few days, several stocks are bouncing back into prior support levels which may act as resistance. If the underlying downtrend resumes, it is likely these stocks will fail at these levels, likely presenting great shorting opportunities.
Kennametal Inc. (NYSE:KMT) for instance, had been attempting to consolidate after a sharp drop in late July. It struggled near its 50-day moving average on a few occasions, before ultimately bowing to selling pressure in early October. It rebounded back into the base and is now approaching its 50-day moving average from underneath again. While bear trap can't be ruled out since it rebounded so quickly, it more likely will encounter some selling pressure from trapped buyers and revisit its lows for at least a retest of support. If the markets run out of steam on this rally attempt, it would likely weight on KMT.


Embraer S.A.
(NYSE:ERJ) is another stock trying to negate its recent breakdown. It had been trading in a rising channel as it consolidated after a nasty decline in August. It recently fell out of the channel as it too, also failed to hold above its 50-day moving average. It is trying to rebound above this level from underneath, but could also encounter significant selling pressure. Traders should monitor how it trades in this area, as a reversal from here could lead to much lower prices.

VirnetX Holding Corp. (AMEX: VHC ) may also be close to encountering some resistance as it attempts to bounce after a breakdown. VHC is now in a downtrend, after topping out in July and then falling into a pattern of lower lows and lower highs. While the current rally attempt may have more room to run, VHC could encounter selling pressure soon. The $20 level sticks out as an area to watch with the confluence of the 50 and 200-day moving averages, as well as this area proving to be important in May and then again in September. Any failure in this area would likely lead to a retest of the October lows.



Philip Morris International Inc (NYSE:PM) is another stock to watch closely as it attempts to climb back into its recent base. PM broke down from a base a few sessions ago after failing to hold near its 200-day moving average. The $64 level is the key area to watch, as this was the bottom of its prior trading range and was acting as a support level. Now that it fell under this level, it may very well act as a resistance area. A reversal here would confirm the pattern as a top, and likely lead to a continuation of the downtrend.

Bottom Line
Shorting stocks is very risky, and much more difficult than buying. The environment that favors shorting is often much more volatile, and as such makes pin pointing entries much more difficult. However, as long as a trader employs discipline, this trading method can help reduce exposure to a portfolio that is holding long positions during a weak market. The key is to recognize areas that may usher in sellers that can provide a trader with a clear stop out level. If the markets continue higher, then the shorts will stop out, and any long positions in the account will benefit. If the markets falter (as the primary trend suggests), then a trader can benefit from the market's weakness.

Charts courtesy of stockcharts.com

At the time of writing, Joey Fundora did not own shares in any of the companies mentioned in this article

Related Articles
  1. Chart Advisor

    Gold Struggles to Climb Higher and May Fall Soon

    Traders will be watching the price of gold over the coming weeks. We'll take a look at how a couple major moving averages are suggesting that the next move could be lower.
  2. Technical Indicators

    Use Market Volume Data to Determine a Bottom

    Market bottoms often carve out classic volume patterns that let observant traders make fast and accurate calls.
  3. Charts & Patterns

    Understand How Square Works before the IPO

    Square is reported to have filed for an IPO. For interested investors wondering how the company makes money, Investopedia takes a look at its business.
  4. Trading Strategies

    Who Actually Trades or Invests In Penny Stocks?

    Although penny stocks are highly speculative, millions of people trade them daily. Here are 10 different types who do.
  5. Chart Advisor

    4 Stocks Still Flashing Buy Signals

    In the midst of volatility and a big market sell-off last week, these stocks are flashing buy signals.
  6. Technical Indicators

    Understanding Trend Analysis

    Trend analysis is the use of past performance to predict future price movement of a security.
  7. Trading Strategies

    How To Buy Penny Stocks (While Avoiding Scammers)

    Penny stocks are risky business. If want to trade in them, here's how to preserve your trading capital and even score the occasional winner.
  8. Chart Advisor

    Stocks to Short...When the Dust Settles

    Four short trades to consider, but not quite yet. Let the dust settle and wait for a pullback to resistance for a higher probability trade.
  9. Technical Indicators

    Using Moving Averages To Trade The Volatility Index (VIX)

    VIX moving averages smooth out the natural choppiness of the indicator, letting traders and market timers access reliable sentiment and volatility data.
  10. Chart Advisor

    Strategizing for a Market Fall...or Rally

    The downtrend isn't confirmed yet, so be prepared with trades for whether the stock market rallies or continues to fall. Here's how to do it.
RELATED TERMS
  1. Fintech

    Fintech is a portmanteau of financial technology that describes ...
  2. Indicator

    Indicators are statistics used to measure current conditions ...
  3. Intraday Momentum Index (IMI)

    A technical indicator that combines aspects of candlestick analysis ...
  4. Mass Index

    A form of technical analysis that looks at the range between ...
  5. Money Flow Index - MFI

    A momentum indicator that uses a stock’s price and volume to ...
  6. On-Balance Volume (OBV)

    A momentum indicator that uses volume flow to predict changes ...
RELATED FAQS
  1. Tame Panic Selling with the Exhausted Selling Model

    The exhausted selling model is a pricing strategy used to identify and trade based off of the price floor of a security. ... Read Full Answer >>
  2. Point and Figure Charting Using Count Analysis

    Count analysis is a means of interpreting point and figure charts to measure vertical price movements. Technical analysts ... Read Full Answer >>
  3. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
  4. How are double exponential moving averages applied in technical analysis?

    Double exponential moving averages (DEMAS) are commonly used in technical analysis like any other moving average indicator ... Read Full Answer >>
  5. How do you know where on the oscillator you should make a purchase or sale?

    Common oscillator readings to consider making a buy or sale are below 20 or above 80, respectively. More aggressive investors ... Read Full Answer >>
  6. What are the alert zones in a Fibonacci retracement?

    The most commonly used Fibonacci retracement alert levels are at 38.2% and 61.8%. A 50% retracement level is also commonly ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!