Is The Stock Market Rebound Setting Up A Short Selling Opportunity?

Stock market short opportunity?

The U.S. stock market, measured by the Dow Jones Industrial Average (^DJI) and the NASDAQ Composite Index (^IXIC), is set to end the week higher than where it finished last week – capping a wild week on a quiet note. The NASDAQ was trading down 8.9 percent at one point early Monday morning before rallying back strongly to finish the week close to 12 percent above those midday Monday lows.

The problem with the current setup in the market is that it has been under distribution. Technical analysts monitor days when the stock market trades up or down on heavy volume and call these days distribution or accumulation days.

Investor’s Business Daily uses the accumulation/distribution profile to help identify major market turning points – the newspaper changed its outlook to downtrend after Monday’s selling. Trade in the stock market today, the height of the recent rebound, is running well below average.

Gil Morales, former Chief Market Strategist for William O’Neil and Co., the investment arm of IBD, appears to view the current stock market rebound as a potential short selling opportunity – comparing the recent volatility with the “flash crash” of 2010 in a series of recent tweets.

While many have referred to the recent volatility as a stock market crash, MarketWatch Co-Founder Kevin Marder notes that markets in 2008 and 1987 were much worse.

“While some may term this a “crash,” it does not compare at all with either the fall of 2008 or the granddaddy of them all, October 1987. For instance, the former saw the S&P drop 35% on an intraday basis from Sept. 19 to Oct. 10.”

The Standard & Poors 500 Index (^GSPC) Index dropped five percent intra-day on Monday. This was a big move to be sure, but nothing compared to what the stock market demonstrated in the past. Marder is currently advocating cash positions for investors, as he was well before the commencement of this week’s market volatility.

While the great majority of investors go long only, short sellers play an important role in the stock market and the economy. Historically, markets that limit or ban short selling have been shown to begin trading away from fundamentally sound valuations. Short selling has been an integral part of U.S. stock markets since their inception, though even in the United States, the practice periodically comes under attack, especially when market volatility is encountered. Before this week’s global market rout, Business Insider had reported on why recent efforts by the Chinese government to stop short sellers would prove to be futile.

[Photo by Andrew Burton/Getty Images]