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TRADING SYSTEMS


AK Steel And The Near-Term Short Setup

06/16/10 09:33:09 AM
by Donald W. Pendergast, Jr.

The broad markets hit a speed bump on June 14, 2010, setting up a number of interesting short-sale situations. Here's a look at one of the more promising plays.

Security:   AKS
Position:   Sell

George Angell's Long, Sell, Short Sell (LSS) system seeks to profit by identifying what Angell believed to be a recurring three-bar cycle in various markets. I've done extensive testing of this system on a variety of stocks, fine-tuning it to work well without a lot of frequent optimization. Like many trading systems, it seems to produce substantially better results when traded in the direction of the primary trend of the market in question. For example, daily based LSS results are usually better if the stock or commodity is already enmeshed in a strong weekly trend. Swing traders using 30- to 60-minute bars for LSS signals may find their system results to be greatly enhanced if the daily chart of the stock is already in a strong up (or down) trend. The standard LSS utilizes no initial stop-loss (since the system is always in the market, either long or short), but adding an 8% to 10% initial stop-loss helps contain losses on the occasional trade that goes haywire. With all that said, here's my take on an attractive LSS short sell signal in AK Steel (AKS).

FIGURE 1: SHORT-SALE CANDIDATES. When evaluating among potential large-cap short-sell candidates, always focus on the stocks that are near the bottom of the relative strength list versus the S&P 500. In this example, shares of AK Steel are exceedingly weak versus the S&P 500 over the past 13 weeks.
Graphic provided by: MetaStock.
Graphic provided by: MetaStock Explorer.
 
AK Steel shares are in a fairly strong weekly downtrend, well below their 12-week exponential moving average (EMA) (which is also sloping downward), and the stock is also very weak in terms of its relative strength ranking versus the Standard & Poor's 500 (see Figure 1). In addition, AKS also suffers from weak long- and short-term money flows, a key tipoff that a stock may be destined for a period of continued weakness, if not further declines.

FIGURE 2: AKS, DAILY. With the Fibonacci 200% extension support of major swing 1-2 already violated, a retest of the early June low at $12.48 may be AKS's next order of business. Should the low at $12.48 give way on big volume, a move to $11.90, the Fibonacci 127.2% support of major swing AB could be a real possibility.
Graphic provided by: MetaStock.
 
On Figure 2, the daily chart, you can see all of the LSS trading signals for AKS over the past nine months. This is a very active trading system, and the new appearance of an LSS short sell signal in the context of a severe bear market in AKS shares is a very interesting event, especially given the nice pullback higher toward the $14.50 area and the fact that the next support in this stock isn't seen until $12.48, the recent swing low. This creates an excellent risk-to-reward ratio short trade setup in a weak relative strength stock that is burdened with negative money flows.

Traders entering at the next session's open might consider placing a stop-loss near $14.70 and then holding on for a possible move down to $12.48, especially if the broad market continues to go lower for the next few days. Should $12.48 be reached, consider taking at least half of your position off (if not all of it) and running a closer trailing stop, like a two- to three-bar trailing stop of the daily highs. If you see $12.48 taken out on heavy volume, then there is a high probability that the Fibonacci 127.2% extension support of major swing AB (see blue highlights) may also be achieved on further weakness in AKS and the broad market in general. All in all, this looks like a very attractive near-term short setup in a stock where the "line of least resistance" (one of the legendary trader Jesse Livermore's favorite sayings) certainly appears to be "lower."



Donald W. Pendergast, Jr.

Donald W. Pendergast is a financial markets consultant who offers specialized services to stock brokers and high net worth individuals who seek a better bottom line for their portfolios.

Title: Writer, market consultant
Company: Linear Trading Systems LLC
Jacksonville, FL 32217
Phone # for sales: 904-239-9564
E-mail address: lineartradingsys@gmail.com

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