Shorting The Defensives

While the tech bear market is getting long in the tooth, if you dig into the sectors, you still can uncover deteriorating stocks with enough of a potential downside to take the odd short. That's why I'm paying closer attention to the so-called defensives -- in this case, healthcare.

If you must short this late in the game, it's probably a good idea to look for medium- and short-term trades in the areas that fell apart later in the bear.

Shorting the defensives also gives you some hypothetical protection against mark turns. If we are near a bottom, chances are money will rotate into the economically sensitive companies and the perceived value opportunities scared up by capitulation selling, which can accelerate the selling in the defensives.

Let's look first at Cisco Systems (CSCO | Quote | Chart | News | PowerRating), Yahoo (YHOO | Quote | Chart | News | PowerRating) and Broadcom (BRCM | Quote | Chart | News | PowerRating). These stocks have been in powerful downtrends for more than a year. All are trading at fractions of their all-time highs. All have extended well below their 200- and 50-day moving averages.

There are two ways to short: off a reversal pattern indicating that a stock is shifting from uptrend to downtrend, or off a continuation pattern, indicating that a stock, which has paused in the midst of a downtrend, is in the process of resuming that downtrend. What the medium-term short seller trader seeks in a continuation-pattern entry is a well-established downtrend. Cisco, Yahoo and Broadcom head lower? Sure. But none have "paused" -- in the form of upward wedging action or four-to-seven-week inverted patterns -- to clear out the short-covering and bottom feeders before resuming their downtrends.

Compared to the techs and the Nets, the healthcare sector is in big trouble as well. However, it swam against part of the current before peaking in late 2000. So this raises the odds of catching more of a remaining down move than in a sector or group which has made a longer extended run into new lows. You can see this in the Dow Jones Healthcare iShares (IYH | Quote | Chart | News | PowerRating), an Amex-listed exchange-traded fund that tracks the Dow Jones U.S. Healthcare Sector Index.

Now let's look at Abbott Laboratories (ABT | Quote | Chart | News | PowerRating). Abbott is a healthcare products company and thus represents a defensive play. True to form, Abbott swam against the bear market, rising more than 80% to its 52-week high of 56 1/4 high on Nov. 30, 2000, from its close of 30 15/16 on March 10 of that year (the date of the Nasdaq peak). Since then, the stock has fallen in line with the general downtrend.

In January and February of 2001, the stock tried to rally back but formed a lower high and rolled over. The reaction move carried the stock above its 50-day and 200-day moving averages, then broke back below them, meeting a key requirement of the inverted cup-with-handle. For more on this pattern, see my report, Using Inverted Cup-With-Handles To Identify Shorting Setups.

The stock now is in an appropriate area to form a handle. Ideally, it heads lower first and forms the handle just above support at 42 a share, but these entries don't always set up for our convenience! Abbott Labs moved up 1.6% Wednesday on mediocre volume, closed in the lower half of its range and put in an inside day following Tuesday's decline. You could set 1/8 point below the Tuesday low as your pivotal point. Of course, use stops and position sizing on every trade!

For an introduction to combining price stops with position sizing, see my lesson, Risky Business. For further treatment of these and related topics, check out the Money Management area of TradingMarkets' Stocks Education section.