Time Warner (TWX | Quote | Chart | News | PowerRating) announced Wednesday morning that it was splitting off its cable television division. Was this an opportunity to buy or sell the newly cable-free Time Warner?
It is hard to say right now. But a few days ago Time Warner was a stock trading below its 200-day moving average with a Short Term PowerRating of 3. And we think that a trader’s attitude toward stocks that are under their 200-day moving averages and sporting low Short Term PowerRatings should always be the same: time to avoid – or sell short.
Look at the PowerRatings chart of Time Warner over the past 30 days. Notice how the stock is trading below its 200-day moving average – signaling its weakness as a stock – and is alternately rising above and falling below its 5-day moving average. We use the 5-day moving average as an exit signal, as I will show later. For now, focus on the fact that the stock is below its 200-day moving average.
Notice also how as Time Warner rallies towards its 200-day moving average from below, its Short Term PowerRating decreases. This reflects our understanding of how markets really work, an understanding embedded in our Short Term PowerRatings. As a stock’s Short Term PowerRatings grow smaller, we recognize that the chance of a stock being able to outperform its peers in the near term also grows smaller. At its most extreme, with stocks that have Short Term PowerRatings of 3 or less, they become stocks that our research indicates are likely to actually underperform the average stock. The stocks with the lowest possible Short Term PowerRatings, for example, have been found to underperform the average stock by a margin of nearly 5 to 1.
Time Warner did not have the lowest possible short Term PowerRating during the past 30 days. But on two separate occasions the stock had its PowerRating downgraded from 4 to 3. And although this did not make Time Warner one of those stocks likely to underperform the average stock by 5 to 1 – or close to it, it did suggest that the stock was more likely to be lower than higher in the near term.
Notice both instances in which Time Warner’s Short Term PowerRating dropped to a three in the PowerRatings chart above. On both occasions, Time Warner either sold off or moved sideways for the next few days. In both instances, the fact that Time Warner’s Short Term PowerRating fell to a 3 provided a warning to traders that the stock would have a difficult time moving higher.
And because the stock was below its 200-day moving average as well, that PowerRating of 3 also marked Time Warner as a potential short term trade to the short side.
Let’s take a look at a few quick examples. We like to place limit orders above the close of a stock we are looking to sell short. This helps make sure we are selling as high as possible. A limit order placed above the close of the day in which Time Warner became a 3-rated stock, in both cases shown, would have likely been filled on the following day, or the day afterwards as the stock continued to drift higher.
So, short around $16.25 in the first instance and short around $16.50 in the second. How do we get out? Remember that 5-day moving average I mentioned in the beginning? A close below that level is our exit signal.
In the case of the first trade, Time Warner closed below its 5-day moving average on May 7th at approximately $15.94 for a 30 cent gain. In the second trade, Time Warner closed below its 5-day moving average on May 20th at $16.15 for a 35 cent gain.
These are not trades we would take. We like for Short Term PowerRatings to drop to 2 or even 1 before betting against the stocks that have them. But even this illustration involving a 3-rated stock shows how our Short Term PowerRatings – combined with some basic entry and exit rules – can be an effective approach to short term stock trading for many traders.
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Whether you have a trading strategy of your own that could use a boost or are looking for a way to tell the stocks that will move higher in the short term from the stocks that are more likely to disappoint, our Short Term PowerRatings are based on more than a decade of quantified, backtested simulated stock trades involving millions of stocks between 1995 and 2007. Click the link above or call us at 888-484-8220, extension 1, and start your free trial today.
