Trading Ideas For A Market Pullback

The stock market has had one of its best annual starts in history in 2012. The S&P 500 is already up a whopping 7.51% for the year, and the market looks like it could continue to grind higher in the near-term. Given the continued macro uncertainty surrounding the European debt crisis, however, along with the steep advance in the stock market over the last couple of months, many traders are probably wondering if a sharp pullback might be around the corner. While it is too early to tell if last year's volatility will be back with a vengeance as we move through 2012, extreme one way moves frequently trigger significant retracements. What sectors and specific stocks are most ripe for a sharp pullback in the event of market jitters? In order to answer that question, I looked for sector ETFs that are significantly outperforming the broader market and could be setting up for a reversion trade. In addition, I scanned for the biggest winning stocks of 2012 that have a high short interest - suggesting that hedge funds and other traders are skeptical that the gains will continue.

- The biotech sector has probably been the best performer of 2012, vastly outperforming the broader market. The XBI is already up more than 19% in 2012 which compares to a gain of 7.51% for the S&P. The divergence between the two is substantial, and the odds are that in a pullback, XBI will fall precipitously more than the broader S&P. Traders looking to put on a reversion trade could buy the SPDR S&P 500 ETF

and sell the XBI expecting that the performance gap between the two ETFs will close.

- While this appears to be a risky trade, as financials have been extremely strong in 2012, the fact is that financial stocks are the most exposed to the European debt crisis - and remain in a brutal long-term downtrend. The XLF is up roughly 13% year-to-date, and those gains could rapidly evaporate with the next round of market volatility. At these levels, shorting the XLF could yield significant rewards, but traders should use tight stops in case the market continues to rally.

- The XHB has been ripping in 2012 on the back of better than expected economic and employment numbers. The ETF has already risen more than 18% on the year and will almost certainly pull back if the current market optimism turns to fear in the coming months. This is another high risk/reward trade, but if you remain skeptical of a sustained turnaround in housing, this is the way to play it. Traders looking to hedge their bet could buy the SPDR Dow Jones Industrial Average ETF

to offset their short XHB position on the thesis that large cap blue-chip names will outperform homebuilders if market sentiment shifts and investors become more risk averse.

All of the stocks listed here are up more than 50% in 2012 and have a short interest of above 20%. Traders looking to enter these names on the short side should look for signs that the recent relative strength is fading before taking a position so as not to get caught in a continued short-squeeze. Shorting stocks that already have large short interests can be risky, so use stop losses.

- Shares are up 51% in 2012, but hedge funds and individual traders are still betting against this name. With the stock down better than 80% over the last 52-weeks, AMSC has a short interest of roughly 31%. On Thursday, the stock has lost almost 8%, suggesting that the momentum might be fading.

- This stock remains in a long-term downtrend, but has spiked 132% in 2012. Undoubtedly, this is a scary name to short, but the rewards could be substantial. Traders looking to take a position on the short side should wait for the upward momentum to reverse so as not to get caught in a short squeeze. Currently, around 32% of COCO's float is sold short suggesting that the market isn't buying the big rally in the name.

- This biotech name has been propelled higher by better than expected quarterly sales results for the company's prostate cancer drug Provenge. Year-to-date, the stock has soared better than 94%, but is still down 58% over the last year. Around 23.48% of DNDN's float is sold short. There could be money to be made on the short side if DNDN cracks, but be sure to protect yourself in the event of a continued squeeze higher.

- Netflix has always been a heavily shorted stock and this has led to elevated volatility in the name. After falling from over $300 in 2011 to a low of $62.37, NFLX has doubled and currently trades at $124.84. Year-to-date, shares are up more than 80%. When the company reported its most recent earnings results in January, the share price jumped from $95 to $116 overnight, which has created a big gap in the chart. Short-sellers might want to take a bearish position in the name looking for that gap to be at least partially closed - although NFLX still looks like it could run for awhile. In any event, the market isn't completely convinced that NFLX has put its troubles behind it, as 21.79% of the float is still sold short.