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Finding Short Candidates With Technical Analysis

When short circuit actions, one is often faced with the challenge of distinguishing between a Trim training and a change of orient oneself. Many successful short sellers will try to focus their efforts by looking at the clues offered by schools of technical analysis and fundamental analysis. Read on to learn how studying these different methods can help a trader gain confidence in shorting the market.

Technical analysis

Since equity markets are mainly dominated by long traders, short traders try to tackle weak desires trigger breaks and start bearish trends. They try to put enough pressure on the market to create situations where the weaker get away with it for a long time for fear of returning the gains. It is the job of the short seller to find tools, such as different chart patterns or indicators that are used specifically to predict the onset of a decline or panic selling.

Trying to sell a market using technical analysis usually means finding a overbought indicator and a trend indicator reliable enough to show that equity is a candidate for a downward move. The overbought indicator is most likely either a relative strength index (RSI) or a stochastic oscillator. A trend indicator can be as simple as a short-term indicator moving average (MY).

When using an oscillator, the trader relies on it to show that the market has reached a level indicating that it may be lacking buyers. A trend indicator, on the other hand, is usually used to show that Support was broken off because the market weakened. When shorting a stock, it is very important for the trader to know that with an oscillator he is selling strength, but with a trend indicator he is looking to sell weakness.

Fundamental analysis

Basically, there are several ways to identify short applicants, including bad income, lawsuits, changes in legislation, and news. The key to using the fundamentals or news to trade stocks short is to make an informed decision as to whether the event that is occurring is a short-term issue or a long-term event.

A negative news event is more likely to cause a downward spike in a market and not necessarily cause a good long-term decline. In this case, the spike was most likely caused by stop loss orders being triggered. A long-term decline may start with a downward spike, but is most likely triggered by a series of negative events that give traders confidence that a longer-term downtrend is developing.

An example of a downward spike triggered by a news event is when a company’s earnings are reported below consensus. Traders respond by selling the stock. A series of negative earnings reports, however, is the type of fundamental that often attracts the short seller.

When an event is large enough to break market support, volatility will often increase as nervous long traders begin to feel pressure from short sellers trying to drive the market down. This is when a trader can use both types of analysis to determine the severity of the downside ahead.

In general, a negative news announcement is often accompanied by heavy volume and wide ranges as short-selling pressure intensifies in a bid to drive the stock higher to technical levels that will trigger more sell stops. The short seller, driven by the confidence of negative fundamentals, continues to try to push the market through support points, making it difficult to hold long positions.

Short selling in action

Large volume, wide ranges and lower closes often attract the attention of short traders. After further investigation, the short trader will then decide that the news event or fundamental is strong enough to trigger a liquidation of the long positions. These conditions may encourage short sellers to initiate new short positions.

A good example of this type of setup took place in the S&P Financial SPDR Funds (AMEX:45) in early 2007. Figure 1 illustrates how short sellers identified a potential opportunity and used negative evidence from technical and fundamental analysis to gain control of a falling market.

Figure 1 (Source: TradeStation)

Short sellers saw volume increase and eventually triggered a downward acceleration.

After a prolonged rise and a series of higher highs and lows, the RSI and Stochastic indicators reached overbought levels. This was enough information for traders to believe a top was forming, but not enough to attract selling pressure because throughout the upswing the same oscillators had been indicating possible tops.

The XLF offered the first hint of a high on February 20, 2007, at 37.99, and began its breakout at 34.18 on March 14, 2007. This move was the largest downward move in price terms. and time the market has seen since 2004. Compared to previous breaks, this move was much more severe, which was a major hint that XLF was in the lead, as seen in Figure 2.

Figure 2 (Source: TradeStation)

The severe break in February and March made it clear that XLF was in the lead.

Although technical factors may have identified a possible top, news reports helped traders gain confidence in the short side by fueling the market with negativity. On February 26, 2007, the former Federal Reserve Chair Alan Greenpan warned of a recession by the end of 2007. The following day, the Shanghai Composite Index fell 8.8%. European equities also saw significant one-day declines, and the Dow Jones Industrial Average (DJIA) fell sharply.

During these broad market breakouts, XLF also came under short-selling pressure, as bearish traders interpreted this as a sign that a recession could possibly reduce future profits for financial institutions.

The first decline was triggered by a combination of technical and fundamental factors. It offered clues to traders that the XLF was sensitive to news that had a potential effect on futures earnings. He also identified price levels in the market that could have been defended by long traders. In February and March, it was reported that several subprime companies had filed for bankruptcy. This news, along with Mr. Greenspan’s comments, most likely contributed to the decline in XLF from February 20 to March 14.

As the market formed its top in early spring, more fundamentally bearish data was released which painted a bleak picture when combined with the weakening technical pattern. In early April, New Century Financial Corporation filed an application Chapter 11 bankruptcy protection. While this news may not have immediately triggered a market breakout, when combined with the subprime bankruptcy filings in February and March, a bearish fundamental trend began to form.

XLF showed a downward price trend throughout the spring and summer. During this period, short sellers likely gained confidence from unfavorable fundamentals, news and visibly bearish chart patterns. Short sellers were likely encouraged by negative-toned news reports that sowed pessimism among investors. Meanwhile, the technical patterns on the charts continued to reaffirm the downtrend with a series of lower highs and lower lows shown in Figure 3.

Based on the combination of technicals and fundamentals, it was clear that the short sellers were in control of XLF.

Figure 3 (Source: TradeStation)

The series of lower highs and lower lows indicate a clear downward trend throughout the spring and summer months.

The essential

In summary, being a successful short seller requires being aware of the indices that are offered both technically and fundamentally. Technically, the short trader must be able to distinguish between a leading formation and a trend change. They must learn the types of formations that indicate a short-term top or a long-term trend.

Basically, the short trader must distinguish between a one-off news event and the start of a series of negative events. By learning how techniques and fundamentals work together, a trader will gain confidence, which can help them comfortably go short in the market.

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