Baiting Razorfish

The market continues to punish bad news and hand bears gap-down short candidates. On Friday, shareholders drop-kicked Razorfish after the Internet consultant warned it would miss 3Q expectations.

Razorfish (RAZF | Quote | Chart | News | PowerRating) gapped down and fell 3 3/4 to 5 on volume of 15.5 million shares. Over the past 50 sessions, daily volume has averaged two million shares.

Readers of this column will recognize Razorfish as the most recent of a slew of stocks that have gapped down on heavy volume, creating an opportunity to short if (1) the stock subsequently bounces and (2) then stalls and resumes the decline.

The bearish signs add up quickly for Razorfish: stock in a long-term downtrend, trading below 50- and 200-day moving averages, new price low, close in the bottom third of the day's trading range, and massive cash outflows as evidenced by huge volume accompanying a severe price markdown.

The idea here is to find shortable stocks where the will of shareholders to stand and fight has been broken. I don't want to see signs of a battle between buyers and sellers. I want sellers triumphant at the end of the day, as evidenced by a close in the bottom half of the day's open. 

Take a look at the chart of CMGI (CMGI | Quote | Chart | News | PowerRating). The stock closed at 21 1/2 on Thursday. On Friday, the stock dropped to an intraday low of 18 3/16 but managed to pare its losses to close at 20 13/16 in the upper half of the day's range.

By one definition, Friday would qualify as a distribution day for CMGI. The stock closed down on an increase in volume over the prior session. However, the picture is a bit fuzzier when you look at the share price on an intraday basis. Professional dollars obviously came in to push the share price up into the upper half of the range. That's accumulation.

Which force will prevail? I wouldn't hazard my money on a forecast in this case. To my eye, CMGI is more likely to head lower from here. That reflects my respect for the obvious power of the downtrend -- CMGI has Relative Strength scores in the single digits for the past 12, six and three months and an Average Directional Movement Index of 40. (ADX does not measure direction of a trend. It measures the strength of a trend. Scores above 30 reflect strong trends.)

But the stock's putting up a fight. The upper-half range close on huge volume could signal a bottoming action. There's clearly a battle between supply and demand. 

I don't want to get into the middle of a fight. I'm a coward. I want to put the odds as much as possible in my favor. I commit my capital to a long trade only when I think buying pressure is overwhelming selling pressure, to a short trade only when I think the reverse is occurring.

For more on interpreting the balance between supply and demand, I strongly recommend you read Kevin Haggerty's lesson, Selection Of Trades By Identifying Buying and Selling Pressure.

All stocks, of course, are risky. In any new trade, reduce your risk by limiting your position size and setting a protective price stop where you will sell your new buy or cover your short in case the market turns against you. For an introduction to combining price stops with position sizing, see my lesson, Risky Business. For further treatment of these and related topics, you'll find extensive lessons in the Money Management area of TradingMarkets' Stocks Education section.