Two Ways Of Playing The Stock Market: Long and Short

Today I want to talk about a few ways to play the market.

First off, the market, in general, has been having a tough time. Over the last eight weeks, the Dow has fallen more than 1,200 points, or approximately -9.3%. In addition, the market has been trading under the psychological support level of 12,000 for the last few days.

Nobody knows what’s going to happen in the market with the next support levels coming in at around 11,200 and 10,800 – but there seems to be a lot of downside pressure and risk.

Of course, we could go right back up to 13,000 as well – which is where we were only two short months ago.

So what to do?

There are a couple of things. You can make money on both the long side and the short side. In other words, you can make money when the market goes up or when the market goes down.

Everybody understands the concepts of buying stocks and how they make money when the market goes up. It’s the old adage of buy low, sell high. Or buy high and sell higher.

And even when the market is going down – there are always stocks going up. Always. You just need to find the right ones while staying away from silly risk. Try to focus on the best sectors and industries, and diversify your portfolio so you’re not too concentrated in just one or two areas.

I’ll get into a few more specifics in a bit.

But the other way to make money is to be a short seller. That means instead of losing money when your stock goes down – you can make money.

This utilizes the same concept of buying low and selling high. The only difference is, as a short-seller, you’re doing it in reverse. You’re selling it first, and then buying it back at a presumably higher level.

Buy low, sell high (in this case it’s sell high first, then buy low later).

In essence, you never really own the shares. You’re borrowing them from your brokerage company and selling them into the market. If the price drops, you can buy them back at a lower price, return the shares to your broker and keep the profit.

Of course, if the price goes up, you might end up buying them back at a higher price – this of course would result in a loss.

Nonetheless, the concept is the same. If you think a stock is under-priced and should go up, you can buy it and make money. If you think a stock is over-priced, you can sell it and make money as it falls.

There’s nothing really scary about it. And it gives your portfolio additional flexibility.

You’ll need to check with your brokerage company to get set up for this. And you’ll also find that you won’t be able to short all stocks as some stocks are hard to borrow. But there are plenty available.

For those who don’t want to sell short (or let’s say can’t because they’re trading in a qualified account), you might also consider buying put options instead. It’s a fine alternative to try and make money as the price of a stock falls. Just be smart about the options you buy. Personally, I like buying in-the-money options with good deltas.

So…How to screen for these two types of stocks?

Long

Screening for top buying candidates is pretty simple. But in this environment, I would suggest looking for stocks with a Zacks #1 Rank or Zacks #2 Rank - maybe even a Zacks #3 Rank. (But stay away from Zacks #4 Ranks and Zacks #5 Ranks.)

There will surely be Zacks #4 Ranks and Zacks #5 Ranks that might go higher, but the odds are against you. Since roughly 70% of stocks go down when the market is bearish, you need to try and tilt the odds in your favor as much as possible.

So stick with the best Zacks Rank stocks, and try specifically looking for upward earnings estimate revisions in both the F1 and F2 periods. (F1 being current fiscal year and F2 being next fiscal year.) Increases on the quarterly numbers are fine, but look for yearly numbers. You want to make sure this good news isn’t some one-quarter phenomenon, but rather a longer term, sustainable growth forecast.

Since we’re talking about growth, make sure they have positive growth rates moving forward as well.

You can also add in a price change component such as stocks up 10%, or more, than the market. Or maybe just >= 10% in absolute terms. Either way, you want stocks that are demonstrating their ability to buck the market’s down-trending ways.

Short

As for the short end, I first like looking for higher-priced stocks. It’s not to say that lower priced stocks can’t fall. But I prefer seeing something higher in price.

Then search for Zacks #4 Ranks or Zacks #5 Ranks. You can also search for Zacks #3 Ranks as well, but make sure they have negative earnings estimate revisions for this year and next. Diminishing forecasts for a company one and two years out is a big negative on a stock.

Top it off with high valuations like a high P/E ratio of 40, 50 or above its industry’s average. Then add in some other negatives such as a bigger debt load — and in a falling market, these are the kinds of stocks likely to get punished the most.

Here are two stocks that came out of the long screen and two stocks that came out of the short screen.

Long stock candidates:

The Children’s Place Retails Stores, Inc. [[plce]]
United States Steel [[x]]

Short stock candidates:

Las Vegas Sands [[lvs]]

DST Systems, Inc. [[dst]]

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