3 Earnings Stocks Traders Like to Short

04/21/2014 10:30 am EST

Focus: STOCKS

Thomas Aspray

, Professional Trader & Analyst

Even though the materials sector has been one of this year’s top performers, a few stocks in this group set to report earnings this week have been targeted by short sellers, so MoneyShow’s Tom Aspray investigates whether these bearish bets are justified or not.

The long weekend has not hit the market with any significant shocks though the Shanghai Composite did lose over 1.5%, but Eurozone stocks are firm. The US futures are higher as the positive tone from last week has continued.

The strong readings from the market internals discussed in Friday’s Week Ahead review makes a new high in the S&P 500 likely over the next month. On a short-term basis, the odds do favor a slight pullback this week.

There are many economic reports this week that will give us a further read on manufacturing, as well as the housing market. Many traders are betting on weak earnings this week for three stocks in the materials sector, even though the Select Sector SPDR Materials (XLB) is one of the year’s best sectors, up 2.8% YTD versus just a 0.9% gain in the Spyder Trust (SPY).

Do the weekly charts of these three stocks favor the traders’ bearish bets or are they likely to get squeezed?

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Chart Analysis: The Select Sector SPDR Materials (XLB) tested its 20-week EMA last week before closing the week strongly.

  • XLB tested its starc+ band in early March when it made a high of $48.26.

  • The quarterly pivot at $46.11 (see table) was tested last week before it closed strongly.

  • The weekly starc+ band is now at $49.60.

  • The relative performance broke out to the upside in February as it overcame resistance at line b.

  • The RS line is rising strongly and is close to new highs.

  • The weekly OBV moved through its resistance, line c, in late January soon after it gave an AOT buy signal.

  • The weekly WMA of the OBV is rising strongly.

  • The XLB has short-term support in $46.70-$47.20.

Cliffs National Resources (CLF) is a high-yield stock I have been cautioning investors about for several years and most recently in January’s 3 Market Dogs Still Barking. It has a current yield of 3.2% and reports earnings on April 24.

  • As of the end of March, there were 51 million shares sold short with a short ratio of 10.8.

  • CLF was down 34.7% in 2012, 30.5% in 2013, and 21.4% YTD, which has made it a real loser despite its high yield.

  • The weekly chart shows a long-term downtrend, line e.

  • The stock completed its bear flag or continuation pattern (dashed lines) in early 2014 as it broke support at line f.

  • The stock has just turned down from its declining 20-week EMA.

  • The relative performance also shows a pattern of lower highs and lower lows.

  • The RS line has just tested its declining WMA.

  • The weekly on-balance volume (OBV) broke its support (line h) in the middle of January confirming the price action.

  • The recent rally failed below the quarterly pivot at $21.44 with the monthly projected pivot support at $16.11.

NEXT PAGE: 2 More Short Favorites to Watch

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AK Steel Holding Corp. (AKS) reports its earnings on Tuesday, April 22, and there are 44 million of its shares sold short with a short ratio of 5.8.

  • The stock is down almost 12% YTD but was up 78.3% in 2013.

  • The weekly chart shows that it exceeded its weekly starc + band in late 2013 (see arrow) as it had a high of $8.47.

  • AKS closed last week below its quarterly pivot at $5.89 with monthly projected support at $6.32.

  • The weekly starc- band is at $5.52 along with major 50% Fibonacci retracement support.

  • The weekly relative performance peaked with prices at the end of 2013 and is now testing its WMA.

  • The RS line has long-term support at line b.

  • The weekly OBV had been in a tight range, so far this year, but has now broken its support at line d.

  • The monthly projected pivot resistance at $7.11 was tested two weeks ago.

Arch Coal, Inc. (ACI) also reports its earnings on Tuesday, and as of the end of March, there were over 37 million shares sold short. It has a short ratio of 4.2.

  • The stock has been in a broad trading range, lines e and f, since last summer.

  • The upper boundary of the range was tested with the high at $5.37.

  • There is next support at $4.74 with the quarterly pivot at $4.53.

  • The lower boundary of the trading range (line f) is at 3.90, which is very close to the weekly starc- band.

  • The relative performance has also been in a trading range and needs to move above the resistance at line g to signal it is a market leader.

  • The weekly OBV does look much stronger as it broke through resistance (line i) at the end of March.

  • There is resistance now at $5.20 with the projected monthly resistance at $5.53.

What It Means: The Select Sector SPDR Materials (XLB) looks strong, and I would look to buy it at slightly lower levels this week.

Of the three heavily shorted stocks that report earnings this week, Cliffs National Resources (CLF) continues to look the weakest. It has the best chances of rewarding those on the short side.

AK Steel Holding Corp. (AKS) looks to be undergoing a normal correction and could be a buy once the correction is over.

The volume in Arch Coal, Inc. (ACI) does look more positive, and I will be watching it if it drops back towards the $4.50-$4.85 area.

How to Profit: For the Select Sector SPDR Materials (XLB), go 50% long at $47.08 and 50% at $46.16, with a stop at $44.47 (risk of approx. 4.6%).

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