8 Sectors to Consider Shorting
Wednesday, April 22, 2009 | Teeka TiwariRating:
The funny thing about strong upward moves in the market is that people become more bullish, the higher something spikes. In the early part of a sector's move, this sentiment is appropriate. But as the move in the sector lengthens and widens, you reach an inflection point and the continued bullishness becomes a warning sign.
Locate the Bears' Lair with the Bullish Percent Index
At Sector Hunter, we measure these warning signs using NYSE Bullish Percent Index charts. The Bullish Percent charts tell us what percentage of stocks are on a Point-and-Figure buy (P&F) signal vs. a Point-and-Figure sell signal.
I’m not going to bore you with the minutiae of interpreting P&F data; just know that it’s the most-accurate method I’ve found for gauging relative risk in the stock market.
Presently, the Bullish Percent charts are flashing strong warning signals on several sectors. And while many of these industries still “look good” to the general public, they could be on the verge of reversing course. At the very minimum, new buys should be avoided within the following eight sectors: Asia, heavy machinery, steel, metals (non-ferrous), restaurants, insurance, banks and Wall Street.
Right now, four of those eight sectors are showing overt weakness, as opposed to just being overbought. They are banks, Wall Street, insurance and heavy machinery. These sectors are the very heart of the economic growth fantasy ... err, I mean, the story that has been propelling the market higher.
Banks and insurance stocks have been the biggest problem areas of the market. American International Group (AIG), being the mother of all corporate screw-ups, has received more government aid than any other financial institution. So, a breakdown in these groups -- along with the very recent breakdown in Wall Street stocks -- could portend something much darker for the rest of the market.
You must consider this a warning shot across the bow. The bear armies appear to be marshaling their forces. Be very suspect about putting new money to work here. From a quick look at the charts that we use over at Sector Hunter, we could be just a few days away from a slew of short-sale recommendations.
3 Ways to Play These 8 Ailing Sectors
If we are indeed embarking upon a transition period from an up cycle to a down cycle, then there are some concrete things that you can do about it.
First and foremost, stop all new stock buys. The time to get rampantly bullish was back in late February and early March.
If you haven’t been in on the market action for the last few weeks, now is NOT the time to try to become a hero. Opportunity in the stock market is limitless, so exercise a little patience and you’ll get another chance to buy 'em cheap again.
Now, I'm not saying that you have to bail out of the market altogether. Instead, just keep some powder dry for some new buys at a later time.
This brings me to my second point, which is that you want to ensure that every open position you have is accompanied by either a stop-loss or hedged with a put option.
This includes positions that you are profitable on. The worst feeling in the world is watching a profit turn into a loss. A little game planning beforehand can make all the difference in the returns that you experience this year.
Setting a stop-loss is a personal decision -- the "right" level depends on your risk tolerance. Some investors prefer to set their stops at a particular percentage (i.e., 8%-15%, or any other level they designate) so that they are automatically taken out of the position if it happens to hit their specified level. Others prefer to employ the use of a "trailing stop," which they can adjust as the position progresses, to protect their gains along the way.
There's another way you can protect your existing capital without hiding it under your mattress, and that's by buying put options for protection. When you buy ("buy to open") a put, it's a bet that a particular stock, index or sector will drop.
Some investors choose to insure their overall portfolios by buying puts on a major index, to position themselves to make gains to offset any portfolio losses. You can also buy puts to protect individual stock positions. Or, if you're truly bearish on a stock or sector, you may look into simply buying puts to profit from downside without owning the underlying security at all.
This segues well into my third tip for surviving and thriving in this market, which is to keep your eyes peeled for new shorting opportunities. We’ve experienced a dramatic run-up since the March lows, and we are overdue for some type of corrective market action. There is no reason why you can’t profit from both sides of the market -- both on its way up and on its way down, and at every level in between.
You'll want to have an options trading account, if you choose to be short by buying puts. And definitely talk with your broker about ensuring that you're set up to trade on margin, so that you'll be all set to short stocks as soon as the opportunities arise.
Any way you slice it, the intermediate- and longer-term trend is fraught with volatility and uncertainty. We don’t have the luxury of being in a multi-decade bull market like we saw in the '80s and '90s. We are in a protracted, long-term bear market that will be frequently punctuated by very sharp relief rallies.
So, don’t fall in love with any one side of the market ... especially when you can love (read: profit from) both equally!
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Teeka Tiwari
Chief Investment Officer
ETF Master Trader
