How market conditions change the risk/reward of shorts

This is an observation that I have been working on for weeks and wondering about for months. Most traders have heard the adage that most stocks follow the market, yet this platitude is unhelpful and too overgeneralized to be useful. And what about the kind of stocks that we like to short, anyway? The junkers, pigs, etc.? Don't they trade independently of the market? The answer, like always, depends on the stock- and the numbers provides a useful insight into how and when to make trades and some surprises about whether or not the risk/reward is still on your side. Many times it isn't when you think it is.

To illustrate, let's take a look at my watchlist for potential shorts for Monday Oct 13. Of course Monday turned out to be a huge market rally (the biggest point gain in history) so what better to use as the most stringent conditions for our analysis?

Here is the results from that watchlist:

Not a great result for a list that was supposed to be for shorting. But one thing was missing from the analysis: I was focused on RSI(2), and while I believe that to be an important indicator, it is not a controlling variable. The more important controlling variable seems to be how the particular stock performs under general market conditions. Now, thanks to the incredible RamtaJogi, we have the co-relation calculator.

The co-relation calculator is simple: plug in a stock and an index to see how the stock performs. Let's look at some stocks on the list and some old favorites to see what the numbers reveal.

By far, the most meaningful insight is that the risk/reward on most shorts changes dramatically whether the market is red or green. Here is ICO:

Shorting ICO when the $DJI is green as opposed to red changes your probability of success from 76% to 23%. That's a pretty dramatic shift and one that most people are unaware of. Similarly, here is PNX:

The risk/reward changed on Monday from 76% to 30% odds of success. I tried to short PNX that day and took a loss. I never would have made the trade if I had access to this information. As you can see from the update, both ICO and PNX finished up on the day. What about YRCW, you ask? It performed well as a short against the market. And the numbers reveal it:

YRCW shows a propensity for going red both on Dow up days and down days. The risk of shorting YRCW on DJI green was much less here.

Let's look about on one of our old favorites, SIL:

Again, a great independence shows that shorting on $DJI green is no more risky than on red. The astute reader might ask if the numbers are self-referential; are the numbers good because we are taking into account the incredible down move by SIL that we all took advantage of? The answer is no. Looking at earlier data that preceded the big upward move and subsequent down move, from July 1 to Sept 1, showed that the tendency was always there.

The independence of SIL was always there, making SIL one of the best risk/reward shorts on its huge run up in recent memory. This independence also makes trades like SIL good multiday holds where PNX is not.

As you can see, market conditions are much more of a controlling variable than RSI(2). Although this is just one consideration to make in the selection of stocks to trade (where the stock is in relation to its own chart is still paramount; and RSI(2) is still a good indicator of weakness to be used in making the best selection), I believe this is important enough to be considered very carefully.