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.
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