Exploiting the Downside of the Markets

by: Mark Krieger November 20, 2008 | about stocks: AAPL / AMZN / GOOG / QQQQ / RIMM    

Mark Krieger

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The old adage, "if you can't beat them, join them", is quite relevant in this very horrific market environment. The brutality of the market's dive has been severe and it might just be the time to rethink your strategy. Wouldn't it be prudent to initiate a 180 degree turn by unloading your long holdings (I know it's hard selling your positions at such low prices) and replacing them with corresponding short positions?

To sell short, all you need to do is open a margin account. The transaction is just the opposite of going long, as you sell first and buy later. The objective is to buy back the shares at a price lower than you sold them for, thus pocketing the difference as your profit.

The good thing about shorting is shares usually drop farther and faster on bad news than they rise on good news. A new law went into effect making short selling easier, as you no longer need an "uptick" to open a position. The bad thing about shorting is you have unlimited risk, as a stock has no limit on how high it can go, but with a long position, the most you can lose is your investment.

This strategy of selling your long positions and then going short, offers two very strong attributes: (1) it immediately terminates your daily losses by exiting your long positions (2) It enables you to quickly begin offsetting those losses by generating nice returns, as your short positions begin generating hefty profits.

Shorting high and covering low: I always like to try and short stocks when they are high (they have a longer distance to drop, and are usually overvalued and over hyped) and cover them after they have imploded. Since the markets have already dropped more than 40%, it's not as easy to find stocks that are in nosebleed territory, but the trend is so powerfully down, shorting at this juncture is easier than shooting fish in a barrel. Anybody doing it now looks like a genius.

How low will it go? The markets are close to a bottom, and 7500 low seems realistic. The worst case scenario would be another 40% plunge from these levels, taking the Dow down to the 5000 area, but it certainly won't be straight down if it occurred. The market will ratchet up and down, and for every three lost rungs on the ladder, one will be gained through intermediate rallies, as each rally is eventually met by sellers attempting to exit. Bearish sentiment is extreme, as the media, analysts and retail investors have all fallen into a deep panic mode. Extreme pessimism is typically a good indicator of an intermediate market bottom, so a 5-10% rally from these levels is a possibility, before the next leg down, again, rears its ugly head.

Shorting candidates: Seek out stocks that have substantial debt and poor liquidity. These risky stocks present the highest probability of chapter 11 outcomes. Select stocks that exhibit poor relative strength. Good candidates for short sales are stocks that fail to advance despite an impressive rally in the overall markets. Stocks making new 52 week lows are also good targets, because their support levels are non existent.

Favorite shorts: Remember Cramer's Four Horseman: AAPL, GOOG, AMZN and RIMM—Jim Cramer was touting these stocks as the best thing since sliced bread, and had placed outrageous price targets on each and everyone of them. He turned out to be dead wrong, as anybody taking his advice would have taken a catastrophic hit. Despite their significant haircuts, these stocks still represent good shorting opportunities, as they still offer additional downside potential. I wouldn't be surprised to see AAPL drop another $30, GOOG fall $100 and both AMZN and RIMM fall into their mid thirties.

Bottom line: The trend is your friend. Although you might be getting in late in the game, there is still ample downside to exploit. Why not make some of your money back?

Disclosure: Short AMZN, AAPL, GOOG, RIMM and QQQQ.

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This article has 18 comments:

  •  
    Nov 20 06:18 AM
    In today's decline, AAPL exhibited relative strength. It has the potential to deliver a big upside surprise in the Dec. quarter--from early sales reports it's shaping up well. Please place a stop loss on your position.
    Reply | Link to Comment
  •  
    Nov 20 06:18 AM
    In today's decline, AAPL exhibited relative strength. It has the potential to deliver a big upside surprise in the Dec. quarter--from early sales reports it's shaping up well. Please place a stop loss on your position.
    Reply | Link to Comment
  •  
    Nov 20 07:11 AM
    Thanks for outlining your strategy. It's nice to know that we all can participate in kicking the economy when its down to make a couple of bucks. Its the same mentality that cooked up MBS and subprime lending as the consquences being someone elses problem. Shorting, shoplifting, drinking and driving - hey, everyone is doing it and getting away with it, why shouldn't we all? We should write to our congressmen and tell them the bailouts are getting in the way of our disinflationary profit chasing.
    Reply | Link to Comment
  •  
    Nov 20 07:37 AM
    If Apple trades at 2 times cash the world will have ended.
    Reply | Link to Comment
  •  
    Nov 20 07:39 AM

    No question, AAPL is the best out of the bunch and a $90 stop loss order is set in place to protect the position in case they try and run this puppy up.It could bounce to $110 in no time if AAPL beats eps estimates.

    On Nov 20 06:18 AM Roger Knights wrote:

    > In today's decline, AAPL exhibited relative strength. It has the
    > potential to deliver a big upside surprise in the Dec. quarter--from
    > early sales reports it's shaping up well. Please place a stop loss
    > on your position.
    Reply | Link to Comment
  •  
    Nov 20 07:50 AM
    LOL. This article is late to the game man. The S&P500 is getting close to the previous bear market lows and the NASDAQ is approaches rock bottom prices that we haven't seen since the tech bubble collapse. The risk reward for shorting here is way off balance. There's maybe a case to short AMZN here with a P/E that is twice that of AAPL, GOOG and RIMM. But shorting AAPL and RIMM here is a dangerous game. GOOG might make for a good short as the market is laboring under the belief that on-line advertising has disappeared. How long this could be kept up is anyone's guess. GOOG and AMZN are maybe shorts if you're in for a very quick trade. But I wouldn't even think about shorting AAPL or RIMM. That's just stupid. AAPL has been steadily outperforming the market over the past few weeks and while the NASDAQ continues to make new lows, AAPL has yet to break its low set in the first week of October. RIMM has been on fire as of late. Shorting these stocks would have been advisable during the first week of October, but doing so now is a disaster waiting to happen. If history has taught us anything, bear markets end with inverted head and shoulders and when the market rebounds, it does it fast and furious.

    Here's how the S&P, NASDAQ and DJIA bottomed in the 2001-2003 bear market:

    stockcharts.com/h-sc/u...=$SPX&p=D&st=2...

    stockcharts.com/h-sc/u...=$INDU&p=D&st=...

    stockcharts.com/h-sc/u...=$COMPQ&p=D&st...

    Notice how each of them ended their respective downtrends with an inverted head & shoulders. Also, the 74' bear market ended in the same manner. Inverted head and shoulders.

    Now take a look at this bear market. I see a distincted left shoulder, and a head in progress.

    stockcharts.com/h-sc/u...=$COMPQ&p=D&yr...

    Shoulder at 1,542.45; head being made right now; and I imagine we see a massive rally in December as hedge funds try to cut their losses on the year. I could see the NASDAQ testing the neck line at 1700. Then sometime in January, I see the NASDAQ putting in a right shoulder. If the economic data starts look positive, this bear market will be over by March. And you want to short here? You're playing with fire.
    Reply | Link to Comment
  •  
    Nov 20 08:30 AM
    Amazing, the numbskulls who watched the market crash while listening to the morons on cnbc should try to make it all back by shorting stocks after they've gone down 50%? Do you also try to cook food AFTER you eat it? That's not even late to the game, it is late to the season.

    Instead of simply cementing losses, you set them up for total annihilation if the market rallies.
    Reply | Link to Comment
  •  
    Nov 20 09:13 AM
    he's short already, and he wants people to sell him the stock so he can buy it from them at these levels.
    Reply | Link to Comment
  •  
    Nov 20 09:20 AM
    The trend remains down until proven otherwise, and there is still significant risk to the downside here with commercial real estate bonds starting to implode. The relief rallies lately have been pathetic and the institutional buying non-existent; go long at your own risk here. The financials are telling us a story this week--anyone not listening will pay the price.

    Instead of shorting, though, I'm playing 2x inverse ETFs like SKF, FXP, SRS, etc. Measured risk and leveraged potential reward if your timing is good. Take a look at the performance of OTM NOV call options on SKF Wednesday--close to a 1000% gain in one friggin trading session.
    Reply | Link to Comment
  •  
    Nov 20 10:13 AM
    Spot on. As per Bill O'Neil, the best shorts are the high-fliers of the previous bull market, i.e. the four horseman. While they might be the last to fall, it is inevitable. I think it might be too late in the game to open positions now, but it certainly is no time to go long.
    Reply | Link to Comment
  •  
    Nov 20 10:36 AM
    Andy Zaky, you're the best! i'm just stunned by the lack of understanding most so called experts have of Apple, the company...which, of course, means there's no way they can evaluate the stock realistically. Warren B says he doesn't invest in tech stocks because he doesn't understand technology itself. He has a lot of company in that inability to understand, only most of those people don't know it.

    It's understandable in a way...after all, Apple does everything first and it's new and 'out of the park' innovative. They've been underestimated for a long time. Remember when people said the OS wouldn't make it...that the stores wouldn't make it....that people had walkmans, what did they need an ipod for?....that it was WAY too late to go into the music business...that it was even later to go into the 'phone' business...and that no one could make a phone a gaming instrument... wrong, wrong, wrong...etc. talk about being misunderstood...people who are very tech savvy and on the cutting edge (first adaptors, usually) really understand this stuff.
    Thankfully, you weighed in on this post. I always look for your comments.
    Reply | Link to Comment
  •  
    Nov 20 10:44 AM
    Read Mr. kreiger's aug 18 article and he was calling for a pullback on AAPL then...I told readers in May that AAPL would be 120 by Nov. and was laughed off the board...

    Don't ya hate people that say "I told you so"..
    Reply | Link to Comment
  •  
    Nov 20 11:09 AM
    Bear market over by March?.. LOL


    On Nov 20 07:50 AM Andy Zaky wrote:

    > LOL. This article is late to the game man. The S&P500 is getting
    > close to the previous bear market lows and the NASDAQ is approaches
    > rock bottom prices that we haven't seen since the tech bubble collapse.
    > The risk reward for shorting here is way off balance. There's maybe
    > a case to short AMZN here with a P/E that is twice that of AAPL,
    > GOOG and RIMM. But shorting AAPL and RIMM here is a dangerous game.
    > GOOG might make for a good short as the market is laboring under
    > the belief that on-line advertising has disappeared. How long this
    > could be kept up is anyone's guess. GOOG and AMZN are maybe shorts
    > if you're in for a very quick trade. But I wouldn't even think about
    > shorting AAPL or RIMM. That's just stupid. AAPL has been steadily
    > outperforming the market over the past few weeks and while the NASDAQ
    > continues to make new lows, AAPL has yet to break its low set in
    > the first week of October. RIMM has been on fire as of late. Shorting
    > these stocks would have been advisable during the first week of October,
    > but doing so now is a disaster waiting to happen. If history has
    > taught us anything, bear markets end with inverted head and shoulders
    > and when the market rebounds, it does it fast and furious.
    >
    > Here's how the S&P, NASDAQ and DJIA bottomed in the 2001-2003
    > bear market:
    >
    > stockcharts.com/h-sc/u...=$SPX&p=D&...
    >
    > stockcharts.com/h-sc/u...=$INDU&p=D&...
    >
    > stockcharts.com/h-sc/u...=$COMPQ&p=D&am...
    >
    > Notice how each of them ended their respective downtrends with an
    > inverted head & shoulders. Also, the 74' bear market ended in
    > the same manner. Inverted head and shoulders.
    >
    > Now take a look at this bear market. I see a distincted left shoulder,
    > and a head in progress.
    >
    > stockcharts.com/h-sc/u...=$COMPQ&p=D&am...
    >
    > Shoulder at 1,542.45; head being made right now; and I imagine we
    > see a massive rally in December as hedge funds try to cut their losses
    > on the year. I could see the NASDAQ testing the neck line at 1700.
    > Then sometime in January, I see the NASDAQ putting in a right shoulder.
    > If the economic data starts look positive, this bear market will
    > be over by March. And you want to short here? You're playing with
    > fire.
    Reply | Link to Comment
  •  
    Nov 20 01:46 PM
    The sheep are eventually going to catch on to Apple's positives, and the shorts are going to take their profits. Combine the two and the stock could jump 33% in a month--or less. The good news is starting to accumulate. For instance, Blackberry's Storm is getting poor reviews and the press is beginning to recognize the game-changing potential of the latest iteration of the Apple OS, Snow Leopard. Here's a link to a site that accumulates links to the latest stories on Apple: www.macdailynews.com/

    @Kingsley: AAPL actually fell first, leading the decline. It's therefore less likely that it has further to go.

    @Andy: I think that once Apple shows it is not suffering disproportionately from the recession, as conventional wisdom thinks it will, but on the contrary that it can "outrun the bear," it won't matter what the market as a whole does. (I don't see it rising very much after 2008, but rather moving sideways on high volatility for several months.)
    Reply | Link to Comment
  •  
    Nov 20 02:30 PM
    Where did you learn English? In America? What does 'would of... mean? Even K-12 kids in far distant lands know better than this.
    Otherwise, quite a good article, if a rehash of widely understood basics.
    Reply | Link to Comment
  •  
    Nov 21 03:25 AM
    Let me recap the article for you:

    "Hello silly longs! Mark here, folks, hey who do these losses feel? Bad huh? Well, psst, let me whisper in your ear. See, it doesn't have to be that way. You can look like a genius like me, and make money too! Just short everything! It's easy! It always works! "Short & Hold" baby! Here's 4 stock tips to get you started - I did a lot of research on these. Here's my investment thesis, I'll write it doesn on this piece of napking: "Short these stocks because Cramer liked them at some point before". That's it! Just go run through those old Cramer tapes, short it all, that's all you need!

    Why be a sucker when you can make easy money like me!"
    Reply | Link to Comment
  •  
    Nov 22 01:59 PM
    When the money is easy you are likely on trecherous ground. The very best trades/investments are made when you are nauseous immediately afterward. The harder it is to pull the trigger the more likely it is to be right - and vice versa.
    Reply | Link to Comment
  •  
    Dec 14 08:53 AM
    A good short is QQQQ, it has rallied too much in too short of a timeframe and has gotten frothy. A profit taking correction is due.
    Reply | Link to Comment
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