The Dow Jones Industrial Average fell more than 3,000 points before bouncing on Feb. 9, setting off a round of bottoming calls by market players fixated on buying the dip. The recovery wave may have now run its course, with the venerable instrument set to test and possibly break the corrective low, heading for longer-term support near 20,000. This selling wave could generate profitable short sales in the Dow's most vulnerable components.
It's easy to uncover these potential losers with a simple market scan that sorts Dow components by percentage above or below the 200-day exponential moving average (EMA). Manual review is then needed to find the most favorable risk/reward setups because many beaten-down issues have hit extremely oversold technical readings, making further downside less likely. General Electric Company (GE) offers a perfect example, trading near a six-year low after a vertical slide. (See also: Effective Ways for Finding Winning Trades.)
Keep in mind that many components pay quarterly dividends that become your responsibility if holding the short sale through the ex-dividend date. Use careful timing to avoid this unpleasant payoff, tracking the ex-div date before taking the sale. In turn, that may limit the holding period, which is probably a good thing given the market's tendency to squeeze short sellers repeatedly during a correction.
McDonald's Corporation (MCD) shares hit an all-time high near $180 in late January and sold off, dropping nearly 25 points into the 200-day EMA. On-balance volume (OBV) took a major hit during the decline, dropping to the lowest low since November. The monthly stochastics oscillator entered a long-term sell cycle at the same time, predicting relative weakness will persist well into the second quarter.
The stock failed to bounce with the broad market into this week's reversal and is now testing the corrective low in a wide-range triangular pattern, with a breakdown opening the door to 2016 support in the $130s. Traders should pay close attention to the unfilled April 2017 gap between $134 and $138 after a breakdown because healthy buying interest could return once it is filled, setting up a long-term buying opportunity. (For more, see: Why McDonald's Oversold Stock Still Looks Expensive.)
Merck & Co., Inc. (MRK) stock has underperformed its blue-chip peers for several years and may be headed into a long-term downtrend. The stock completed a round trip into the 2007 high in the low $60s in 2015 and sold off, posting an August low in the mid-$40s. It returned to resistance in August 2016 and spent more than a year pushing against the formidable barrier but failed to break out once again.
A steep decline into November 2017 got bought, generating a proportional bounce into January 2018, followed by a secondary downturn that is testing support at the three-month low. Bulls need to hold the line because continued selling pressure may reach the 2015 low, completing a long-term double top pattern. A breakdown at that level may be catastrophic for long-suffering shareholders, favoring a trip into last decade’s bear market low near $20. (See also: How Merck Found Its Way Into Millions of Medicine Cabinets.)
Exxon Mobil Corporation (XOM) hit an all-time high above $100 in July 2014 and sold off into the mid-$60s in the third quarter of 2015. The subsequent bounce stalled out in the mid-$90s one year later, generating a complex corrective pattern that has carved two vertical peaks and two deep lows. Price action has now settled on intermediate support at the August 2017 swing low in the mid-$70s.
The stock is deeply oversold but failed to bounce during the recent recovery wave, highlighting extreme weakness that could signal a breakdown and continued decline into the 2015 low at $66.55. In turn, that would complete a multi-year head and shoulders topping pattern that projects a measured move target into the $20s or $30s. However, multi-year support in the mid-$50s could offer a more reliable turning point. (For more, see: The Top 3 Exxon Mobil Shareholders.)
The Bottom Line
The weakest components in the Dow Industrials have been sold aggressively in recent weeks, generating technical damage that favors profitable short sales into the second quarter. (For additional reading, check out: The Basics of Short Selling.)
<Disclosure: The author held no positions in the aforementioned securities at the time of publication.>