As you can see:

• GOOG broke the up-trend after establishing a new 52-week high above $629 (point #1).
• From there, it consolidated and formed what is referred to as the minor sell-off (the lower horizontal red dotted line).
• Prices started to rise but failed to make another new high. This test of the previous high failed near point number 2 (March & April).
• A failure to make a new high is usually (not always) a signal that the trend is about to change. This is where some traders jump in early.
• Lastly, we reach point number 3 where prices drop below the previous short term minor sell-off (this is trend reversal and the signal to short). If missed, you can short on the first failure to recover the major moving averages (or #3 area which then turns to resistance).

This is the pattern I am watching setup in dozens of stocks across multiple industries. I am also watching this pattern to potentially setup in the major indices as well.

Remember, have patience and be prepared to sit on the sidelines for a while as this pattern takes time to build and then confirm (4 months for GOOG). The key word is CONFIRMATION!

You may play GOOG up and down short term but long term, the trend has changed!
Follow me on twitter to watch the stocks currently setting up this pattern (prior to confirmation).

As you can see:

• BLK broke the up-trend after establishing a new 52-week high above $242.
• From there, it consolidated and formed what is referred to as the minor sell-off.
• Prices stared to rise but failed to make another new high. This test of the previous high failed near point number 2.
• A failure to make a new high is usually (not always) a signal that the trend is about to change.
• Finally, we reach point number 3 where prices went below the previous short term minor sell-off (this is trend reversal and the signal to short). If missed, you can short on the first failure to recover the major moving averages (or #3 area).

In addition to the 1-2-3 setup, the stock has also allowed its 10-week moving average to cross below the 30-week moving average with typically signals a change in trend when both lines are starting to point down.

Victor Sperandeo says this about the 1-2-3 setup:

At the point where all three of these events have occurred graphically, there exists the equivalent of a Dow Theory confirmation of a trend change. Either of the first two conditions alone is evidence of a probable change in trend. Two out of three increases the probability of a change in trend. And three out of three defines a change in trend.

Take a look at the picture I scanned from Sperandeo’s book on page 76:

This is essentially the pattern I am watching for in several of the stocks starting to churn (run out of steam) that I posted to my twitter stream. However, have patience and be prepared to sit on the sidelines for a while as this pattern takes time to build and then confirm (nearly four months for BLK).

Twitter stream for 5/17/10 (stocks down on heavy volume, trading near 30-wk): $PCLN, $GMCR, $V, $MA, $TCK, $BUCY, $BTU, $MR

Recent Tweets on BLK:

• 7:33 PM Apr 6th via web: $BLK – 198.55, clearly falling apart (but gap down has to fill before ultimate slide).
• 10:02 PM May 5th via web: $BLK…Trading @ 174.80 & going down!

This is a game of odds with developed expectancies so take the trades and follow the rules.

Characteristics of Trend-trading Shorts

Most ideal longer term trend shorts take four to twelve months after the peak price to setup on the weekly chart with the majority of these shorts triggering between six to nine months.

• Look for stocks that had prior up-trends and support levels that can now act as downward resistance or entry areas.
• Once a stock tops and starts to consolidate, you want it to slice through the 50-d moving average and then the 200-d moving average.
• A crossover between the 50-d m.a. and the 200-d m.a. is ideal and is graphically presented on the KNOT chart
• The odds of success increase with each failed attempt for the stock price to recover these major long term moving averages.
• Head and shoulder tops can also serve as ideal setups for potential shorts if they take at least five months to develop.
• A decreasing relative strength line and a negative pattern on the point and figure chart can also confirm that the stock is rolling over and setting up an ideal short.
• Finally, volume should be increasing and the stock should be under distribution as it violates the major moving averages and starts to break former support levels.

CROX Example:

• Will CROX get Eaten?
• CROX getting Swallowed

To initiate a short sale, you must place the order with your broker or online brokerage by determining the size and price at which the trade will occur. Your broker or brokerage company will check to see if shares are available in the specific stock selected or if they can borrow the shares. Once they are available or can be borrowed, they will be sold in the open market on the first plus tick or continuation of an up-tick also known as zero-plus tick (the stock must move up for the transaction to complete). To close the short position, the broker will purchase the shares using the original proceeds and return the shares to the third party.

As a short seller, you believe that the price of a particular stock will fall in value over time. For example: by establishing a short position for 100 shares in XYZ at $50, the broker will place $5,000 into your margin account. If the stock falls over the next few weeks and you decide to cover the short at $40, you will initiate a buy for 100 shares in XYZ using the money placed in your account when you sold short. The cost to buy back the shares in this example will be $4,000 or $1,000 less than the original short sale amount. This difference in price will result in $1000 cash that will now become your profit.

On the flip side, if the stock was to jump to $60, you would most likely cover your short or have your stop loss triggered, buying back the shares at this price. The cost would be $6000 or $1000 more than the original short sale, resulting in a 20% loss. The broker would take the additional $1000 from your cash account to cover the loss in the short sale. This is how you can lose money when shorting stocks. The higher the stocks rises, the more money you can lose, theoretically resulting with an infinite loss (excluding stop losses and broker margin calls).

If the stock rises in price or if the value of the stocks you are using as collateral goes down in price, you may be forced to add cash to your margin account or cover the short sale prematurely. Keep in mind that you must pay any dividends issued while you are short a particular stock.

The two basic reasons for selling short would be to profit from a stock that you believe is grossly overvalued (fundamentally or technically) or to hedge your account with protection from a down-swing in prices due to anticipated or unexpected events. If the stock continually fails to recover these key trend lines, a further decline may be in the immediate future and you may want to profit from this action. In the second case, you may own several stocks and fear a market downturn is on the horizon but don’t want to sell for certain reasons. Instead, the investor can short specific stocks to hedge their account against possible down-turns. Some investors diversify their portfolio with several long positions and a few short positions.

A short should be covered when it rises above the 200-d moving average and certainly covered when it rises above the 50-d moving average (especially if this line is above the 200-d m.a.). If the relative strength line starts to rise, gradually making its way to new high territory, I would advise covering the short position before a big breakout occurs.

Shorting stocks may contribute to a more consistent strategy throughout up-trending and down-trending cycles. As I have said in this blog before, shorting is not for everyone and nothing is wrong with sitting in cash during bear markets, awaiting the next breakout and a fresh batch of leaders.

Many traders believe that the most obvious area to place a short would be near the peak of stock’s trading range but I have found this to be untrue. Stocks making higher highs usually continue to make new highs so stay away from this strategy.

Additional criteria for shorting candidates can be decelerating earnings and sales and a relative strength line heading down. Investors can also take the characteristics that we use for locating long positions and reverse the criteria to develop a list of possible short candidates. Even familiar chart patterns can be used to spot shorts; the reverse cup shaped base, the head and shoulders pattern and/or the flat base with a stock breaking heavily to the downside on above average volume. Industry groups that are becoming weak or are showing multiple stocks falling and breaking through key trend lines should be noted on a watch list. If one stocks looks like a short candidate, look for additional sister stocks that may have the same set-up. Remember, stocks usually move in groups whether they go up or down.

Setups for Selling Stocks Short

Most important: Always cut your losses quick! This rule applies to any strategy in the stock market.

See my posts below to understand exactly what I am looking for when placing a short trade or buying put options several months out.

• Setups for Selling Stocks Short
• Stages of a Stock Breakdown
• 10-Week Crossing Below 30-Week Moving Average

Stocks Starting to Trend Downward:

• PCP – 110.69, Precision Castparts Corp. is trending lower as the stock is challenging (to move above) the 200-d m.a. for the first time since crossing below the average in January. The stock does sport a 10-week m.a. below the 30-week m.a.
• GME – 47.38, Gamestop Corp was screened back in March as a stock setting up a possible short but it had one last push before starting to crumble again. Now is the more ideal entry area for a short or put options based on the 200-d m.a. and the 10/30-week crossover.
• VOD – 30.10, Vodafone Airtouch is attempting to challenge (move above) the 200-d moving average but doesn’t seem to be having success. The 10-week m.a. is trading below the 30-week m.a.
• GR – 57.96, Goodrich Corp. is down more than 10% this week on large volume as the 10-week m.a. also trades below the 30-week m.a. A drop below $56 would violate all recent support.
• LLL – 101.90, L-3 Communications is down more than 5% this week on above average volume as it violates the 200-d m.a. (for the second time since 2006). The 10-week m.a. is still above the 30-week moving average so I would not short the stock until they cross.
• GOLD – 41.14, Randgold Resources, has started to pullback and violate the 200-d m.a. for the first time since the summer of 2007. It may be early to short for the long term but keep an eye on this stock and the commodity in general. The 10-week m.a. is still above the 30-week m.a. (10-week moving average is now trending downward).
• TEF – 83.21, Telefonica is about six months removed from its high as it trades beneath its 200-d m.a. for the first time in years. The 10-week m.a. is now trading below the 30-week.

Please note that it is still early for a few of the names above (they may have some life left for a bounce higher before a longer term decline).

This is what I had to say a few weeks ago in my post titled DryShips (DRYS) Drying up?

All in all – I am not a buyer of the stock at this level. It may be a solid short term buy for traders that make these types of plays such as Blain and Rajin but it does not fit into my criteria for a trend trading opportunity.

I see a decent consolidation over the past few months but I have a problem with the current pattern that is forming if it does not test former highs near $130. Volume is increasing as it moves higher but the stock is starting to struggle near the last peak of $88.

I stick to my original analysis as I am watching the stock from afar or the weekly chart. I am not day trading DRYS or any stocks for that matter so I can cut through the noise and view the market on a weekly basis to assess the “true overall trend”. Don’t get me wrong, many traders made money on the recent spike in DRYS but I wasn’t touching it with a 10-foot pole. I look for the big runs and couldn’t be bothered with a few points here and there (and I am not about to support my broker with constant buy and sell commissions, even if they are minimal).

The easiest way to characterize this trade and the market in general is to view it all as a risk/ reward potential or an expected value, as I wrote yesterday. DRYS was not a +EV trade in my trading system but, it very well may have been an excellent +EV trade for a shorter term day trader such as Rajin or Blain.

Anyway, here are a few more charts that are starting to look suspicious (some more than others). The bottom line or point of today’s rant is the fact that I still feel that the market is headed for a decline or as I phrased it a couple weeks ago:
The Big Decline (long term perspective of course).

These charts are just examples as many more exist but they were some of the first I viewed Thursday night:

However, historical charts show that the likelihood of an ideal short setup comes when the 50-d m.a. is trading below the 200-d m.a. By the time the 50-d m.a. crosses below the 200-d m.a., a second challenge is taking place and this is where I look to initiate a position. I will be watching these stocks for that type of opportunity.

• NUVA – 33.92, screened a couple weeks back as the stock is now trading below the 200-d m.a. The stock is now trending back towards the 200-d m.a., also known as the next ideal short setup.
• FLIR – 26.36, NuVasive reversed on Friday after a failed attempt to recover the 200-d m.a. The 50-d m.a. is still above the 200-d so this will keep me on the sidelines. However, the failed recovery and a crossover in the future will catch my attention for a trade setup
• DECK – 105.23, the stock has moved from $89.88 to $102 over the past few days as it looks to challenge the 200-d m.a. for the first time. A failed attempt to recover this line will be the first short setup/ opportunity. I would like to see the 50-d m.a. fall below the 200-d m.a. before initiating a position.
• CRL – 56.02, Charles River is in the same boat as FLIR and DECK as the 50-d m.a. is still trading above the 200-d m.a. The stock reversed on Friday as it attempted to recover the line.
• OII – 61.30, the stock was up almost 3% on Friday on strong volume but the 50-d m.a. recently crossed below the 200-d m.a. The downturn of the 200-d m.a. is still premature but the overall trend seems ot be turning downward.
• STRA – 156.00, the strong education stock is starting to hit hard times as the 50-dm.a. is trending downward towards the 200-d m.a. The price is currently challenging the 200-d m.a. for the first time in years.

Recent stocks trending down:

• Daily Screen for Monday 3-10-08
• 10-Week Crossing Below 30-Week Moving Average
• Hurting Stocks to Short?

Stage I
Bunge – 96.00, is a stock that is starting to breakdown after a prolonged period of up-trending price increases. The stock continuously maintained a position above the 30-week moving average after the 10-week moving average crossed above it in the summer of 2006. However, recent action suggests the stock is going to fall as the 10-week moving average is now pointing down on above average volume. A cross of the 10-week moving average below the 30-week moving average is a major red flag and sell signal. The first failed attempt to recover the 30-week moving average is the ideal shorting signal.

Stage II
SYK – 59.74, here is a stock that also enjoyed a prolonged period of up-trending prices from the summer of 2006 until the close of 2007. The stock started to drop hard on above average volume in January of this year and now shows signs of a prime shorting candidate. The 10-week m.a. is now below the 30-week moving average with both lines starting to point south. The next failed attempt to recover either moving average is a short setup. Rallies will occur and this is where opportunity will lie.

Stage III
MS – 38.30, Morgan Stanley is a stock that has been hit hard since the collapse of the credit markets and the sub-prime fallout. The 10-week moving average gave us the exact moment to classify this stock as a red flag back in July of 2007. From there, the stock failed to recover the 30-week moving average and presented a prime shorting opportunity. Only the best traders took this trade as the overall market was still trending higher. The extreme volume confirmed the downward spiral that would follow and the stock has yet to recover the 10-week moving average. Day traders will continue to short every failed rally attempt back to the 10-week or 50-day moving average

BSC – 62.30, Bear Stearns is in the same boat as MS as it is now down more than 60% since it’s high of $170 last January. The 10-week violation of the 30-week line was the first signal back in April 2007. The failed recoveries in the summer of 2007 confirmed this stock was going lower. Again, only the best traders in the world took this trade from a longer term perspective (I was not one of them). Cramer was SCREAMING buy for BSC all summer long – but we already know he is no longer a trader, just a TV personality and that says it all. The failed rally in September and October was an ideal shorting opportunity for second chance(ers). The weakness was obvious at this point but the risk/ reward was still excellent.

Both MS and BSC show us what can happen to the stocks we have been screening in Stage I over the past several nights.

Stage IV
This stage gives us the trash of the market, the worst of the worst! Our representative tonight is Countrywide Financial (CFC – 4.36) as the stock’s 10-week moving average crossed below the 30-week moving average in June 2007. From there, the stock has given traders at least a half-a-dozen shorting opportunities for the intermediate to longer term trader. Stage IV stocks will take a couple courses of action: continue to drop to worthless status or trade along the muck of the market for years to come. Yes, some will recover but I wouldn’t advise bottom-feeding and wasting you hard earned capital with these proven losers.

There you have it, the four stages of a prime shorting candidate from a longer term trader’s perspective.

Recent stocks trending down:

• 10-Week Crossing Below 30-Week Moving Average
• Hurting Stocks to Short?

10-week average below the 30-week average:

• CMTL – 42.59, the stock dropped $4.66 on Friday on volume 147% larger than the average. We also witnessed a large reversal at the 30-week moving average as the 10-week moving average continues to move lower.
• VE – 75.43, the stock was down 15.29% last week with volume 350% larger than the 50-d m.a. on Friday (it was the largest weekly volume in years).
• MR – 30.99, one of the top performing stocks on this blog in 2007; but it is now facing some trouble as the 10-week m.a. is below the 30-week moving average. Volume is starting to increase during distribution weeks.
• MORN – 60.95, the stock failed to complete the $60-$100 run as the 10-week m.a. is now below the 30-week moving average. Volume is increasing with multiple distribution weeks over the past four months.
• SI – 123.53, Siemens is falling on above average volume with a recent reversal at the moving averages. Both the 10-week and 30-week moving averages are trending downward.

10-week average closing in on 30-week average:

• BOOM – 43.38, the former high-flyer was down $10.22 on Friday (volume was 592% larger than average) or 23.88% for the week on the largest volume in eighteen months.
• CRL – 54.10, the stock is falling hard over the past two months on above average volume. The 10-week m.a. is still above the 30-week m.a. but the are starting to turn downward.

Tonight’s stock charts show a declining 10-week moving average that is now trading below the 30-week moving average. The 30-week moving average is just starting to point downward in most of these charts. Trader Vic wrote in his book:

• “When the 10-week moving average crosses the 30-week moving average and the slope of both average is down, this comprises a sell signal, provided prices are below both moving average line”
• “Of course, as with all technical observations, these observations are never right 100% of the time.”
• “The biggest mistake anyone can make in using moving averages, or any technical observation for that matter, is to fall in love with it”

With that said, I will admit that I love using the 10-week/30-week indicator when looking for longer term trend changes and buy/sell signals.

Tonight’s stocks include:
DECK – 105.23 – hat tip to Mike in comments
GME – 45.23
CETV – 84.80
YZC – 76.46
ALXN – 59.20

Add to the fact that they are all several months removed from their 52-week highs and we have PRIME candidates for shorting or put options (whatever your forte).

I detailed the characteristics of longer term shorts in the two blog posts below. The rules in these posts are the exact ones I follow for longer term shorting (I lean towards put options). Remember, I am not day trading for quick profits; I am looking for trends that will last from weeks to months.

• Setups for Selling Stocks Short
• How to Make Money Selling Short

*Disclaimer: These stocks are not trade recommendations; they are purely provided as equity research. Please do your own due diligence and consult a financial advisor before trading (especially shorting).

• CETV – 84.00, the stock was down 9.44% today on volume 764% larger than the average. We will go on to have the largest weekly volume in years by the time the market closes Friday. Lower highs and lower lows with the stock breaking below the 200-d m.a. shows tremendous weakness. A drop to the $66 area and then $55 is not out of the question.
• NUVA – 33.55, the stock was down 4.39% on volume 595% larger than the average. The 13% drop this week has taken the stock below the 200-d m.a. on the largest volume in years. Heavy institutional distribution.
• FLIR – 26.36, the stock was down 9.35% on volume 137% larger than the average. Today’s move took the stock below the 200-d m.a. on heavy volume, the largest in months.
• IBN – 46.91, the stock was down 6.70% today on volume 113% larger than the average. Four consecutive down days has led the stock below the 200-d m.a. on increasing volume. Lower highs and lower lows has been the recent trend.
• YZC – 77.40, the stock was down 7.37% on volume 99% larger than the average. Lower highs and lower lows is the trend as the stock could be headed towards the $64 area and then $50 if the trend continues.