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The Five Best Stocks To Short In May

This article is more than 7 years old.

The Bank of Japan (BoJ) stunned the world last week by holding off on expanding monetary stimulus. With the yen rising and inflation continuing to fall, it was believed that the BoJ has little choice but to pursue even looser monetary policy. Some are grumbling that they were pressured to hold off on additional stimulus to help encourage continuing weakness in the U.S. dollar.

The reactions across global asset classes were immediate and impactful. Gold, silver, and mining stocks popped higher as the U.S. dollar weakened. The yen surged while the Nikkei set the standard for the term “stop run” by falling more than 1000 points in just a few minutes.

More importantly, gold and bonds have decoupled for the first time in over a year, with the stock market now moving down along with bonds. At first glance, bonds selling off doesn’t make sense, especially with weak economies and negative interest rates around the world. Welcome to the world of hedge funds. This is what happens when big trades around the globe are all tied into the same idea – in this case continuing loose monetary policy. The unwinding of those trades can take months, and cause a seismic shift in asset prices and correlated relationships.

Although soaring earnings helped push stocks higher over the past several years, it’s been loose global monetary policy that has kept this bull market alive well beyond the normal five-year stretch. If the mechanism for keeping the market propped up is coming to an end, then the trade needs to be closed.

Money is flowing into energy, mining, and utility stocks. It has to come from somewhere. That somewhere is technology.

My favorite conservative short here is the PowerShares QQQ ETF (QQQ). This is a non-leveraged exchange traded fund that represents the Nasdaq 100 index. While other indexes are holding their recent uptrends, technology as a sector has been the first to crack – even with Facebook , Inc. (FB) making new all time highs. I’m looking for this index to retest – and breakthrough – its February lows. For options traders, buying slightly in the money August put options is another way to play this move. With this strategy, an investor doesn’t have to tie up as much cash and has a fixed amount of risk based on the price paid for the option.

John F. Carter's Tradestation charts of the QQQ's.

For more aggressive traders or traders who can’t short stocks in their brokerage account, then there is two inverse equity ETFs that I like. The first is the ProShares UltraShort QQQ (QID). This ETF goes up when the QQQ goes down and is designed to provide twice the inverse exposure. That is, if the QQQ drops 1%, then the QID goes up 2%. For those looking for more leverage, then look to the UltraPro Short QQQ (SQQQ). This instrument is structured to deliver three times the daily performance.

Regarding individual stocks, it is the former high flyers here that provide the most attractive downside. That said, shorting individual stocks is inherently riskier than an index, and I’m not a fan of shorting a stock just because it seems “too high” in price. As John Maynard Keynes liked to say after he was wiped out betting against European currencies in 1920, “The market can stay irrational longer than you can stay solvent.”

With that thought in mind, I like to see evidence of distribution—no one has ever won a medal for picking the top. An individual stock can land a huge deal, have surprise earnings, or even get bought out. They can also implode much faster than an overall index, which is what makes them attractive shorts.

Although I love Apple Inc. (AAPL) products and use them extensively, at the end of the day, I am a trader. Stock prices appreciate based on anticipation of growth. Prices fall when growth rates slow. Last week AAPL released news of the first quarterly sales drop since 2003. I’m looking for a move to $70. Remember, when investors start heading for the exits, a stock will move down a lot faster than it moved up. Irrationality is king when it comes to panic.

John F. Carter's TradeStation charts of AAPL after earnings.

For the most volatile short, I turn to Netflix , Inc. (NFLX). This is another service I love and use regularly. Tell that to the funds that need to dump liquid technology stocks to put more cash to work in energy and mining. I’m looking for this stock also to head back to $70.

For options traders, buying July in the money put options on these two stocks makes sense, as well as selling call credit spreads for income.

I’m expecting the rest of 2016 to be more volatile, and the recent uncoupling of key asset classes a sign that money is coming out of stocks. I see this as the start of a new trend, not just a whim that turns into a buyable three-day pullback.

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