"An Approach to Successful Stock Trading Combining Company Fundamentals with Chart Technicals"

Monday, May 22nd, 2006

SPECIAL REPORT

- 8 Stocks to Short in This Down Market -
PLUS! : Market Health  | Business Sector Health | Shorting Methods | Eight Stocks to Short

{three days later: GCI (+$1.17), FIC(+$1.84), SRX(+$0.82), MNI(+$1.80), FRX(+$1.09),

DVA(+$1.50), AAP(+$1.46)}

Market health

         Six-Month Cycle | NYSE Point & Figure Charts | Amazing 200 | Sentiment Product


The S&P 500 comprises 80 percent of the market's capitalization, i.e., the majority of its important stocks.  While historically the market has shown a bullish bias (averaging ~7 percent inflation-adjusted return annually), it goes through bearish cycles periodically.  The following weekly chart shows how it has changed over the last 22 months.  For now, ignore the vertical bars separating various terms. Obviously, even over this short period one can identify down periods.  Two questions that I want to address in this report:  (1) can up/down periods be forecasted accurately? (2) how does one take advantage of down periods?

Six-Month Cycle  This cycle of good and bad halves of the year has been well documented and is understandable in terms of money flow.  While there are other important cycles that impact our trading (chiefly the four-year Presidential and the decade cycles), this six-month cycle is by far the most important.  If one had invested $10,000 in 1950 independently in each  of the two, six-month periods (May 1 to Oct 31 versus Nov 1 to Apr 30) and kept that money segregated within the appropriate period each year, i.e., six months in the market and six months out of the market, by 2005 the first would have declined to $9,728, and the second would have grown to $499,981 (+4,900 percent).  In 35 of the last 55 years, the second half of the year outperformed the first half.  The cumulative growth is shown in the following chart.  Note, the two half years have different scales.  Strike one, we've just entered the poor half of the year.

BPNYSE   The NYSE bullish percent (Chart I) is a "point & figure" chart. It tracks the percentage of stocks on the NYSE that are currently giving bullish "p&f" charts, i.e., the number of stocks that have made significant higher highs.  The significance of this chart is that it quantifies bullish strength across the breadth of the market. Note, "p&f" charts in general are unique in their ability to classify each stock (index or most market indicators for that matter) as either bullish or bearish.  The vertical axis charts the percentage and the horizontal time.   The columns of O's mark periods when percentages are dropping and X's mark periods when percentages are rising.  The numbers and letters represent months: 1 to 9 January to September and A to C October to December.

Currently, the BPNYSE chart is bearish because its last signal was made with a lower column of O’s in November 3, 2005 (letter A indicates October). Notice too, the resistance trend line (lower max in column of X's or O's) begun in April ’04 2004 (4 on chart) marks resistance at the patterns top--where 78% stocks gave bullish p&f charts.  The current column of X's needs to fall below 64 percent  stocks giving bullish P&F charts to begin a new column of Os (happened week of 5/19/06).  If 70 percent of the NYSE stocks give bullish signals, BPNYSE will begin a new column of X's.

Currently, the index has fallen and this week (5/19/06) has begun a new column of O's (at 58.32% NYSE companies bullish)--down since it put in a new "X" during the week of 1/31/06. While this action is taking place, remember the technically arguments made above in support of the S&P continuing its fall.  Strike two: the BPNYSE, has now reversed down into a new column of O's (each column usually last months).

Amazing 200   Chart II plots the “amazing 200,” a TSM construct of the number of stocks trading below their respective 200-day moving averages—and another indication of the health in the breadth of the market. It’s zigzag series of bullish (green moving right to left) and bearish (red moving left to right) runs has occurred over the past year and a half. Over this period, the market has been generally bullish, i.e., zigzagging up.  When that changes, it will begin zigzagging down through a new stair-step series of bullish and bearish runs. Note where this metric finds itself at the close of 5/19/06:  well on its way down and to the right.  The three bullish and three bearish periods are those marked on the S&P chart above.  Strike three:  the amazing 200 has now definitely turned bearish, and these linear trends usually last many months.

Sentiment Product  TSM’s fourth measure is the sentiment product, a construct of the VXO (OEX implied volatility) and CBOE’s equity Put/Call ratio. Both measure market sentiment.  As shown in Chart III, this construct, the sentiment product (SP), moves inversely to the S&P, whose 500 stocks capture more than 80% of the total market cap.  As opposed to the first two metrics, which capture the stock performance of the breadth of the market, this one reflects how traders/investors feel about the market. Invariably it shows that fear controls a bottoming market (topping sentiment product) and greed a topping one (bottoming sentiment product); hence the sentiment product is a contrary measure.  Like the “amazing 200,” this independent measure has been been moving up as the S&P pulled back.  Strike four:  the sentiment product is rising as fear enters the market.

There you have it, four independent measures that are signaling a down turn in the market.  Each supports the technical argument made for the S&P’s continued fall.  Will the market continue its fall Monday or even next week?  Or will it rebound?  Who knows?  Suffice it to say, the fall will continue.

 
 

Business Sector health

       

Sector Strength change is clearly shown in the following two charts.  Each one plots each of 31 major business sector's three-month return versus its one-month return.  Each data point's size represents the magnitude of its latest weekly return (green bullish and white bearish).  In December of last year, each of these sectors lie in the top half of the graph, i.e., each sector had a one-month positive return.  Sectors 18 (Internet) and 29 (Transportation) in particular had been performing well.  The second chart shows the relationship five months later.  All, save sectors 15 (Food & Beverage), 22 (Media) and 28 (Tobacco), show a negative return for the latest month.  Notice too, how the Internet sector (18) has moved to the opposite corner of the plot, i.e., it now has the worst performance over the two periods.  Strike five:  nearly all sectors are pulling back.

 

BUSINESS SECTORS      

 1 - Aerospace/
         Defense		   17 - Insurance
 2 - Automotive    18 - Internet
 3 - Banking    19 - Leisure
 4 - Chemicals    20 - Manufacturing
 5 - Computer
       Hardware		    21 - Materials &
         Construction
 6 - Computer
       Software		    22 - Media
 7 - Conglomerates    23 - Metals &
          Mining
 8 - Consumer
       Durables		    24 - Real Estate
 9 - Consumer
    Non-Durables		    25 - Retail
 10 - Diversified
        Services		    26 - Specialty
          Retail
 11 - Drugs    28 - Tobacco
 12 - Electronics    27 - Telecom
 13 - Energy    29 - Transportation
 14 - Financial
        Services		    30 - Utilities
 15 - Food &
       Beverages		    31 - Wholesale
 16 - Health
         Services		 
 32 - Nasdaq    34 - Dow 30
 33 - Russell 2000    35 - S&P 500

 
 

Shorting METHODS

      

A Fundamentals Approach to Shorting Stocks

 Richard W. Miller, Ph.D.

           The market is up one day, down the next. Further, we’re rapidly approaching the bad six months in the market’s half-year cycle. On the one hand, most of us prefer to trade long fundamentally sound stocks. On the other, there’s a problem. We’re rapidly approaching a period when our long picks likely must perform against the market, swim against the current if you will. The biannual cycle is well tested and its reasons understood (see Yale and Jeffrey Hirsch’s “Stock Trader’s Almanac”). You need to be aware because its impact is dramatic. From 1950 through 2005, if you had segregated two, $10,000 accounts, investing one exclusively in the Dow between May 1 & Oct. 31 and the other in the Dow between Nov. 1 and Apr. 30, the first would have fallen to $9,728 while the second grown to $499,981. Chart I shows the daily median close for the last seven years, i.e., the mid daily close for the seven components. The arrows highlight biannual periods.

Trading long over the coming six months is apt to put the wind in your face, so to speak.  Given that environment, how does a fundamentals trader respond:  by not trading, by trading fewer shares, by honoring tight stops, by hedging with options, by taking profits more quickly, and by trading short, i.e., borrowing shares, selling them today then buying them back later.  This last is what I want to talk to you about today.

Perhaps William O’Neil said it best in “How to Make Money Selling Stocks Shorts,”  “It takes real knowledge and market know-how as well as lots of courage to sell, and particularly to sell short, because you will make mistakes.  However, I don’t see how anyone can really do well in the market and protect assets if they don’t learn how, when, and why stocks should be sold.”  Amen.  Let me share the TripleScreenMethod’s (TSM) approach with an example.

When the market environment turns bad {biannual cycle and two market measures, the sentiment product (2/06 CANSLIM.net News), the “amazing 200” (12/05 CANSLIM.net News}, TSM looks seriously at identifying potential shorts, not exclusively, but perhaps matching its number of long candidates.  TSM’s long candidates are based on superior fundamentals, upward earnings revision fuel, value, and technical pullback criteria.  Conversely, TSM short candidates are based on inferior fundamentals, down-ward earnings revision fuel, overpriced value, and technical recovery into areas of resistance.

Consider Kos Pharmaceuticals, Inc. (KOSP).  On 12/15/05 it had a massive sell off on comments by Merck that potentially could impact KOSP’s major product.  A few months later, on 2/23/06, it gapped down on a company warning of reduced 2006 expectations, well below what analysts expected for the year.  Over the past 90 days, its 2006 earnings estimate had dropped 28.4 percent from $3.27 to $2.34, and this year’s PEG (price-to-earnings-to-earnings growth) was –0.87 due to its negative growth.  Fundamentally, KOSP was a good short candidate.

Technically, KOSP was developing a well-defined zone of resistance (shaded area), i.e., an area where its price repeatedly reversed down (in Dec. of 2005 and Feb. this year).  Further, Dec.’s wide-range candle provided further resistance as lots of people buying the big drop awaited their chance to get out at breakeven.

The ideal short point occurred as price approached the shaded zone.  TSM started following KOSP on 3/14/06.  The inserted candle pattern highlights the trade that developed on the 21st as price fell below the low of the previous day (the short point).  The first profit target was set at the prior multi-candle low.  Notice how this area supported price for three days before finally breaking through to the short point.  Five trading days later, price had reached our first profit point, and 1/2 the position was covered for a $1.50 gain (3 percent return).  The 2nd half of the trade exit will be covered through a 2-day trailing stop, i.e., when today’s high exceeds the higher high of the last two days.

Like the long trade, one wants to hit the first technical target, take profit from a portion of the position, then stay with the trade as long as possible with the 2nd half.  Of course, the trade would be protected by a 7.5 percent stop of last resort before the profit point was hit.  If KOSP had recovered to $53.52 at any time over the duration of the trade, the entire position would have been covered. 

The common knock on trading short is the liability incurred as the price climbs.  That’s protected with sound trade management strategy as easily as the liability of a falling stock price is protected in a long trade.  When the market turns down, consider hedging your portfolio with a few short positions.  Note, I usually trade half the size going short that I do going long and freely admit that short trading is more difficult.
 
 

Eight Stocks to Short

        

Market Health is now negative, as measured by a number of independent measures.  Of course, we'll still long for the longs, but now we'll balance those buys with a selection of shorts on stocks that we expect to drop.  The ideal TSM short will technically have a falling 50-day moving average, and we'll look to short when the stock recovers from its fall to a major area of resistance, i.e., a major moving average (20-, 50- or 200-day moving average), a prior high or the top of its Bollinger band.

Company Profile: Gannett Co., Inc. operates as a news and information company primarily in the United States and the United Kingdom. The company operates in two segments, Newspaper Publishing and Broadcasting. The Newspaper Publishing segment publishes 91 daily newspapers, approximately 1,000 nondaily publications in the United States and Guam, and approximately 300 titles in the United Kingdom. This segment also includes commercial printing, newswire, marketing and data services, and PointRoll, an Internet advertisement service. The Broadcasting segment owns and operates 21 television stations that reach approximately 19.8 million households in the United States. This segment also includes Captivate Network, a national news and entertainment network that deliver programming and full-motion video advertising through video screens located in elevators of office towers and select hotels in North America. The company operates Web sites that offer news, entertainment, and advertising content in text and video format to approximately 21 million unique visitors. Gannett has strategic business relationships with online investee companies, including CareerBuilder, LLC; Classified Ventures; ShopLocal, Inc.; and Topix.net. Gannett was founded by Frank E. Gannett in 1906 and is headquartered in McLean, Virginia.

Company Fundamentals and Techncials: GCI is a 13.1 billion market cap company. Its sector is Media (#22); Zacks ranks it a 4 and reports earnings on 7/13/06.  It has produced a 6, -3, 0 & -1 (Mar. '06) percent year-over-year earnings growth. Further, this year's earnings estimates have decreased from 5.21 to 5.02 in the past 90 days, while the number of mutual funds holding shares have decreased from 395 to 359 over the last reporting period.  Short shares when GCI makes falls below the a prior day's low.  Use the prior day's high as a stop-loss point.  Look to cover 1/2 shares at $1 profit and hold remaining 1/2 position until price exceeds prior two day high.

Company Profile:  Fair Isaac Corporation, along with its subsidiaries, provides analytic, software, and data management products and services to automate and improve decisions. The company operates in four segments: Strategy Machine Solutions, Scoring Solutions, Professional Services, and Analytic Software Tools. The Strategy Machine Solutions segment provides enterprise decision management applications for marketing, account origination, customer management, fraud, collections and debt recovery, mortgage lending, and review and repricing of medical bills; and myFICO.com Web site, a source for consumers to obtain their FICO scores and credit reports from the U.S. credit reporting agencies. The Scoring Solutions segment develops FICO scores that are used by credit card organizations, as well as mortgage and auto loan originators to prescreen solicitation candidates to evaluate applicants for new credit and review existing accounts. It makes these scores available through credit reporting agencies in the United States. The Professional Services segment provides solution and technology consulting, systems integration, data management, business strategy consulting, industry consulting, strategy science, predictive science, and fraud consulting services. The Analytic Software Tools segment provides software tools for rules management, model development, and data-driven strategy design. It serves banks, credit reporting agencies, credit card processing agencies, insurers, retailers, telecommunications providers, healthcare organizations, pharmaceutical companies, and government agencies. The company markets its products through direct sales organization, alliance partners, and other resellers in the United States; and through subsidiary sales organizations, resellers, and independent distributors outside the United States. Fair Isaac was founded in 1956 and is headquartered in Minneapolis, Minnesota.

Company Fundamentals and Techncials: FIC is a 2.4 billion market cap company. Its sector is Diversified Services (#10); Zacks ranks it a 5 and reports earnings on 7/27/06.  It has produced a 18, 51, 24 & 44 (Mar. '06) percent year-over-year earnings growth. Further, this year's earnings estimates have decreased from 2.17 to 2.13 in the past 90 days, while the number of mutual funds holding shares have increased from 171 to 185 over the last reporting period.  Short shares when FIC makes falls below the a prior day's low.  Use the prior day's high as a stop-loss point.  Look to cover 1/2 shares at $1 profit and hold remaining 1/2 position until price exceeds prior two day high.

Company Profile: SRA International, Inc. provides information technology services and solutions in the United States. The company offers strategic consulting; systems design, development, and integration; and outsourcing and operations management. Its strategic consulting services include assessment of current operations, development of strategies and plans for improvement, define key priorities and accountabilities, and design enterprise architectures that capitalize on client investments in legacy systems. The company’s systems design, development, and integration services comprise project management, systems design, network and systems integration, security engineering, software development, database design and development, and independent test and evaluation. Its outsourcing and operations management services include various managed services and outsourced solutions. The company’s business solutions include contingency and disaster response planning, enterprise architecture, enterprise systems management, information assurance and critical infrastructure protection, network operations and management, privacy protection, text and data mining, and wireless integration services. The company offers services primarily to the clients in national security, civil government, and health care and public health markets. SRA International was founded by Ernst Volgenau. The company was incorporated as Systems Research and Applications Corporation in 1976 and changed its name to SRA International, Inc. in 1984. SRA International is headquartered in Fairfax, Virginia.

Company Fundamentals and Techncials: SRX is a 1.7 billion market cap company. Its sector is Computer Software (#6); Zacks ranks it a 5 and reports earnings on 8/01/06.  It has produced a 17, 14, 19 & 12 (Mar. '06) percent year-over-year earnings growth. Further, this year's earnings estimates have decreased from 1.14 to 1.06 in the past 90 days, while the number of mutual funds holding shares have decreased from 113 to 111 over the last reporting period.  Short shares when SRX makes falls below the a prior day's low.  Use the prior day's high as a stop-loss point.  Look to cover 1/2 shares at $1 profit and hold remaining 1/2 position until price exceeds prior two day high.

Company Profile: The McClatchy Company, through its subsidiaries, engages in the ownership and publication of newspapers in the United States. It offers daily and nondaily newspapers. The company provides newspapers with content, publishing tools, hosting services, and software development. It also operates local Web sites in each of its daily newspaper markets, which offers information, news, advertising, e-commerce, and other services. The company’s newspapers primarily include the Star Tribune, The Sacramento Bee, The Fresno Bee, The Modesto Bee, The News&Observer, The News Tribune, and the Anchorage Daily News. As of December 31, 2005, it owned and published 29 newspapers. The McClatchy Company was founded in 1860 and is headquartered in Sacramento, California.

Company Fundamentals and Techncials: MNI is a 13.1 billion market cap company. Its sector is Media (#22); Zacks ranks it a 4 and reports earnings on 7/14/06.  It has produced a 4, 1, -5 & -10 (Mar. '06) percent year-over-year earnings growth. Further, this year's earnings estimates have decreased from 3.49 to 3.12 in the past 90 days, while the number of mutual funds holding shares have decreased from 71 to 61 over the last reporting period.  Short shares when MNI makes falls below the a prior day's low.  Use the prior day's high as a stop-loss point.  Look to cover 1/2 shares at $1 profit and hold remaining 1/2 position until price exceeds prior two day high.

Company Profile:  Getty Images, Inc. and its subsidiaries provide imagery and related services to businesses worldwide. It offers a range of visual content, including creative or stock imagery that include still and moving images; editorial photography, which comprises news, sports, entertainment, and archival imagery; illustrations; and related services. The company also provides assignment services, such as photographing executives for an annual report, producing product shots for a brochure, and documenting a news event. It serves various customers, including creative customers, such as advertising and design agencies; editorial customers that include publishing and media companies; corporate customers, such as in-house advertising groups and corporate marketing departments; and film customers, including film and broadcast production companies. Getty Images offers its services through its Website, company-operated offices, and a network of delegates. The company was founded by Mark Getty and Jonathan Klein in 1995 and is headquartered in Seattle, Washington.

Company Fundamentals and Techncials: GYI is a 4.0 billion market cap company. Its sector is Diversified Services (#10); Zacks ranks it a 4 and reports earnings on 7/26/06.  It has produced a 41, 36, 39 & 19 (Mar. '06) percent year-over-year earnings growth. Further, this year's earnings estimates have decreased from 2.78 to 2.59 in the past 90 days, while the number of mutual funds holding shares have decreased from 293 to 279 over the last reporting period.  Short shares when GCI makes falls below the a prior day's low.  Use the prior day's high as a stop-loss point.  Look to cover 1/2 shares at $1 profit and hold remaining 1/2 position until price exceeds prior two day high.

Company Profile:  Forest Laboratories, Inc. engages in the development, manufacture, and sale of both branded and generic forms of ethical drug products, as well as nonprescription pharmaceutical products sold over-the-counter. The company’s products include Lexapro, Celexa, Namenda, Tiazac, Benicar, Benicar HCT, Milnacipran, CCR1, Lercanidipine, Campral, and Combunox. The Lexapro and Celexa are used for the initial and maintenance treatment of depressive disorders, and for generalized anxiety disorders. The Namenda, an N-methyl-D-aspartate-receptor antagonist, is used for the treatment of moderate to severe Alzheimer's disease. The Tiazac, Benicar, Benicar HCT, and Lercanidipine are used for hypertension. The Milnacipran is in Phase III development for the treatment of fibromyalgia syndrome. The CCR1 is a chemokine receptor involved in the inflammation process. Campral is used for the maintenance of abstinence from alcohol in patients with alcohol dependence. Combunox, an opioid and NSAID combination, is used for the short-term management of pain. It also has various products under development, which include RGH-188 in Phase I clinical trials, an atypical antipsychotic for the treatment of schizophrenia, bipolar mania, and other psychiatric conditions; phase I completed GRC 3886, a novel, orally available Phosphodiesterase-IV inhibitor in development for chronic obstructive pulmonary disorder and asthma; and Desmoteplase, a novel plasminogen activator, or blood clot-dissolving agent. The company markets its products directly and though independent distributors worldwide to physicians, pharmacies, hospitals, managed care, and other healthcare organizations. The company has strategic alliances with H. Lundbeck A/S; Merz Pharma GmbH; Sankyo Pharma; Merck Sante s.a.s.; Gedeon Richter Ltd.; Glenmark Pharmaceuticals; PAION GmbH; ChemoCentryx, Inc.; Cypress Bioscience, Inc.; and Recordati, S.p.A. Forest Laboratories was organized in 1956 and is based in New York City.

Company Fundamentals and Techncials: FRX is a 12.4 billion market cap company. Its sector is Drugs (#11); Zacks ranks it a 5 and reports earnings on 7/19/06.  It has produced a -13, -25, -19 & 63 (Mar. '06) percent year-over-year earnings growth. Further, this year's earnings estimates have decreased from 2.64 to 2.38 in the past 90 days, while the number of mutual funds holding shares have decreased from 340 to 301 over the last reporting period.  Short shares when FRX makes falls below the a prior day's low.  Use the prior day's high as a stop-loss point.  Look to cover 1/2 shares at $1 profit and hold remaining 1/2 position until price exceeds prior two day high.

Company Profile:  DaVita, Inc. provides dialysis services in the United States for patients suffering from chronic kidney failure, which is also known as end stage renal disease (ESRD). The company operates kidney dialysis centers, and provides related medical services primarily in dialysis centers and in contracted hospitals. Its services include outpatient dialysis services; hospital inpatient dialysis services; and ancillary services, such as ESRD laboratory services, vascular access services, and disease management services. In addition, the company conducts research trials of new pharmaceuticals and medical devices with dialysis patients, and provides administrative support for research conducted by its affiliated nephrology practices. As of December 31, 2005, DaVita operated or provided administrative services to 1,233 outpatient dialysis centers, serving approximately 96,000 patients in 41 states, and the District of Columbia; and offered acute inpatient dialysis services in approximately 795 hospitals. The company was incorporated in 1994 and is headquartered in El Segundo, California.

Company Fundamentals and Techncials: DVA is a 5.3 billion market cap company. Its sector is Health Services (#16); Zacks ranks it a 4 and reports earnings on 7/27/06.  It has produced a 0, -9, 6 & 16 (Mar. '06) percent year-over-year earnings growth. Further, this year's earnings estimates have decreased from 2.51 to 2.39 in the past 90 days, while the number of mutual funds holding shares have decreased from 207 to 199 over the last reporting period.  Short shares when DVA makes falls below the a prior day's low.  Use the prior day's high as a stop-loss point.  Look to cover 1/2 shares at $1 profit and hold remaining 1/2 position until price exceeds prior two day high.

Company Profile:  Advance Auto Parts, Inc. and its subsidiaries operate in the automotive aftermarket industry in the United States. It offers replacement parts, accessories, maintenance items, batteries, and automotive chemicals for cars and light trucks that include pickup trucks, vans, minivans, sport utility vehicles. The company also offers automotive filters, starters, CV shafts, suspension parts, radiators, alternators, spark splugs, engines, brake pads, batteries, transmission parts, transmissions, fan belts, shock absorbers, clutches, radiator hoses, struts, and electronic ignition components. It also provides automotive tires and service. As of December 31, 2005, it operated 2,872 stores in the United States, Puerto Rico, and Virgin Islands. The company was founded by Arthur Taubman in 1929 and is based in Roanoke, Virginia.

Company Fundamentals and Techncials: AAP is a 4.2 billion market cap company. Its sector is Retail (#25); Zacks ranks it a 4 and reports earnings on 8/10/06.  It has produced a 28, 22, 16 & 11 (Mar. '06) percent year-over-year earnings growth. Further, this year's earnings estimates have decreased from 2.45 to 2.41 in the past 90 days, while the number of mutual funds holding shares have decreased from 227 to 186 over the last reporting period.  Short shares when AAP makes falls below the a prior day's low.  Use the prior day's high as a stop-loss point.  Look to cover 1/2 shares at $1 profit and hold remaining 1/2 position until price exceeds prior two day high.

Copyright 2006 TripleScreenMethod.com
It should not be assumed that the methods, techniques, or indicators presented in these pages will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented on these pages are for educational purposes only. These setups are not solicitations of any order to buy or sell. The author assumes no responsibility for your trading results. There is a high degree of risk in trading. I am not recommending that you purchase or short stocks or options using the techniques and methods presented in this report. Trading should be based on your personal understanding of market conditions, price patterns, and risk. I present here information to contribute to your understanding a technique that has worked well for me.