Page 417 - How to Make Money in Stocks Trilogy

Money Management 287

1. The “head-and-shoulders” top. The “right shoulder” of the price pattern
on the stock chart must be slightly lower than the left. The correct time
to short is when the third or fourth pullback up in price during the right
shoulder is about over. (Note the four upward pullbacks in the right
shoulder of the Lucent Technologies head-and-shoulders top.) One of
these upward price pullbacks will reach slightly above the peak of a rally
a few weeks back. This serves to run in the premature short sellers. For-
mer big market leaders that have broken badly can have several upward
price pullbacks of 20% to 40% from the stock’s low point in the right
shoulder. The stock’s last run-up should cross over its moving average
line. The right time to short is when the volume picks up as the stock
reverses lower and breaks below its 10-week moving average line on vol-
ume but hasn’t yet broken to new low ground, at which point it is too late
and then becomes too obvious and apparent to most traders. In some,
but not all, cases, either there will be a deceleration in quarterly earnings
growth or earnings will have actually turned down. The stock’s relative
strength line should also be in a clear downtrend for at least 20 weeks up
to 34 weeks. In fact, we found through research on model stocks over 50
years that almost all outstanding short-selling patterns occurred five to
seven months after a formerly huge market leader has clearly topped.
John Wooden, the great UCLA basketball coach, used to tell his play-
ers, “It’s what you learn after you know it all that counts.” Well, one
know-it-all investor wrote and told us that we obviously didn’t know what
we were talking about, that no knowledgeable person would ever sell a
stock short seven months after it had topped. Few people understand
this, and most short sellers lose money because of premature, faulty, or
overly obvious timing. Lucent at point 4 was in its eighth month and fell
89%. Yahoo! was in its eighth month after it had clearly topped, and it
then fell 87%. Big egos in the stock market are very dangerous . . .
because they lead you to think you know what you’re doing. The smarter
you are, the more losses ego can create. Humility and respect for the
market are more valuable traits.
2. Third- or fourth-stage cup-with-handle or other patterns that have defi-
nitely failed after attempted breakouts. The stock should be picking up
trading volume and starting to break down below the “handle” area. (See
Chapter 2 on chart reading and failed breakouts.)
For years, short selling had to be executed on an “uptick” from the previ-
ous trade. An uptick is any trade that is higher than the previous trade by at
least a penny. (It used to be ⁄8 or ¼ point or more up.) Therefore, orders
1
should normally be entered either at the market or at a maximum, with a