Shorting Stocks - The Basics, Part I of II
What does it mean to short a stock? This means that you borrow the stock from your broker to sell to a third party. The idea is to buy back the stock at a lower price, returning the shares to your broker while leaving the remaining cash in your account as a profit. Put another way, a short seller does not own the stock before they sell it. Instead, they borrow it from another investor who already owns it. At a later date, the short seller buys back the stock they shorted and returns the stock to close out the loan. If the stock has fallen in price since they sold short, they can buy the stock back for less than they received for selling it. The difference is your profit. Short selling is a transaction made on margin. This means that you must open a margin account to sell short. Most online brokers allow you to open a margin account if you qualify according to their rules and regulations. Criteria related to minimum balances and cash reserves may apply. You will sign an agreement with your broker to open a margin account, this agreement says that you will maintain a cash margin or pledge your stocks as margin. (Note: Call your individual brokers for additional questions that you may have). Shorting can be difficult even during a bear market. The conditions must be exactly right for a stock to be considered a short. Just because a stock looks overvalued or high doesn’t mean that it is time to sell this stock short. As I have said before, what looks high to one investor may still be low to another. Two things to take into consideration would be dividends and thinly traded stocks. A stock paying a dividend must be paid by you the short seller when this position is on. Low volume stocks can be very volatile and market makers and money managers can run up the price quickly crushing your short play and adding to your overall loss. If the stock rises above your sell price, eventually you will have to cover your short for a loss. If you have not placed a stop loss, the stock can continue to go higher as your portfolio heads for disaster. Theoretically, a stock can rise infinitely, meaning your losses can rise infinitely. Imagine shorting NVR at $200 a share because you though it was overvalued, only to see it go to $700 per share. I am sure this type of trade would wipe out or leave a big dent in anyone’s portfolio. Many great shorting opportunities come from the same small and mid cap stocks that were once high flyers in previous months or years. For example, TZOO and DCAI were high flyers in 2004 before they became red flags and shorting opportunities. Even large cap companies such as eBay, SBUX and HD can present shorting opportunities at certain points. Ideal shorting candidates will have built several bases over a long period of time resulting in faulty late stage bases as the stock starts to fall. We look towards stocks that have built four or more bases over a few years although this is not always necessary. Stocks such as the mortgage lenders (LEND & CFC) have built many bases since 2002 and have run up several hundred percent. Home builders also fall under this category but have not made our shorting lists as of yet. They have been showing some red flags but support has been noted at or slightly above the 50-d moving averages. Additional criteria for shorting candidates will be decelerating earnings and sales and a relative strength line heading down. Basically take the characteristics that we use for long positions and reverse the criteria to develop a list of possible short candidates. Even familiar chart patterns can be used to spot shorts; the reverse cup shaped base, the head and shoulders pattern and/or the flat base with a stock breaking out to the downside on above average volume. Industry groups that are becoming weak or are showing multiple stocks falling and breaking through key trend lines should be noted on a watch list. If one stocks looks like a short candidate, look for additional sister stocks that may have the same set-up. Remember, stocks usually move in groups whether they go up or down. I tend to look for stocks that are below both the 50-d and 200-d moving averages. Once they slice through both of these lines, I then look for a strong down-trend and a failure to break above the 200-d moving average. This is my ideal time to short a particular stock. Always have a sound exit plan in place with a predetermined stop loss to protect your capital. We typically use a 7-10% stop loss for our long positions depending on the market strength but I would advise a larger buffer for short candidates. A stop loss placed 10-12% from your sell point would be ideal as most stocks have a natural tendency to go up or contain volatility near the shorting sell point. Shorting stocks can be more difficult to learn than buying stocks because a whole new set of rules and bearish short patterns must be learned, on top of your buying rules and chart pattern skills. Shorting can take many more years to master and can provide a shorter window of opportunity as bear markets typically don’t last as long as bull markets do. No matter what strategy you develop with shorting or buying long, you must always stick to strict sell rules. Never argue with a position that goes against you, emotions and pride mean nothing in the market, especially in the short market. Sell all losers immediately before they devastate your portfolio and your confidence going forward. The next article from this two part series will detail the strategies or reasons why you may want to short a stock and a few examples of how shorting stocks can benefit a portfolio during bear markets or sideway corrections, similar to our current situation. Chris Perruna - http://www.marketstockwatch.com Chris is the Founder and President of MarketStockWatch.com, an internet community that teaches you how to invest your money with solid rules. We don't stop at just showing you our daily and weekly screens, we teach you how to make your own screens through education. Through our philosophy, you will be able to create your own methods and styles to become successful. |
Other Online Trading Articles
How You Can Work at Home With Currency Trading and E-currency Exchange Program If you are reading this you probably are looking to work at home. Everyone now a day wants to work at home and spend more time doing the things they love the most. Ever dream of spending time with your loved ones, taking vacations to the islands, or buying that car you always wanted.90% of people that try to work at home FAIL. Why do they ...P/E Ratio - How Valuable Is It? A stock's P/E ratio can be a nice guideline as to the financial condition of a company, but how valuable is that information? To determine that, we need to evaluate exactly what a P/E ratio is. In simple terms it is the stock's current price divided by the previous 12 months earnings per share. However, if you examine the components of the ratio ...Poker and the Stock Market I was out of town this weekend in Southern NJ, Atlantic City to be exact. After finishing my business at the convention center, I traveled back to the newest casino, the Borgata where I was staying for the night. I don’t consider myself a gambler and have never enjoyed losing money at the tables. When I do gamble, my preferred games have alwa ...The Indian Stock Market The working of stock exchanges in India started in 1875. BSE is the oldest stock market in India. The history of Indian stock trading starts with 318 persons taking membership in Native Share and Stock Brokers Association, which we now know by the name Bombay Stock Exchange or BSE in short. In 1965, BSE got permanent recognition from the Governm ...FX Trading Trading money in the global markets can be great way to make more of it, but it can also be a lesson in how to lose money quickly. More than $1 trillion is traded every day on the foreign currency exchange (Forex), and yet no centralized headquarters or formal regulatory body exists for this form of trade. Foreign currency exchange is regulated ...Stock Broker Training If you are thinking of brokering stocks in the stock market but you are worried that you do not have a financial background, then you can worry no more. You only need to have are an interest in the stock market and perseverance to learn.A lot of stockbrokers do not start off as a stockbroker right after college. Many stockbrokers start of ...Seecrets on Investment: Tired of Making Huge Losses in the Stock Market - Part 2 Fundamental analysis.Fundamentals analysis says the best way to predict the future trends of a stock is to understand the financial figures of the underlying company. The fundamental analyst would calculate a theoretical value of the company using cash flow analysis, recent dividends and earnings, future dividends and earnings projections ...Gold is Money Gold always has been and always will be wealth, but using it as money has been a problem. Today there are articles in the financial press that certain countries (usually small ones) are going to go on the gold standard. That means you may turn in your paper certificates for a specified amount of gold.Nixon finally killed off the U.S. gold ...Stock Trading Online – A Quick Guide There is no doubt about it, stock trading can be a risky business and one of your first steps must be to get acquainted with the various tools of the trade. Stock trading is one of the most fun things you can do, but does require a lot of skill and discipline to succeed. You must be realistic and understand that becoming successful at stock trad ...Diversification Wall Street's watchword has always been diversification, but what does it mean and why do they say it?The standard Wall Street definition is flexible because each broker or financial planner will vary the portfolio based on your age and income. They say that the younger you are the more risk you should take and the older you are the less ...What Is Options Trading? If you've been trading stocks for a while and want to do something a little more speculative, then maybe options trading is for you. At a very basic level, an option traded on the stock exchange means 'a right'. So an options trade involves giving someone the right to buy or sell a certain stock at a certain price by a specific time. If you b ...Forex Trading Industry insiders estimate that only about ten percent of the active forex traders make money, and many of those who take part in this heart-stopping game of buying and selling at the slight movement of in the graphs lose large sums of money and capital.Forex trading requires more than just pure luck. Hitting a gold mine means the applica ...Commodity Day Trading Commodity day trading most commonly refers to the practice of buying and selling stocks during the day. By the end of the day, there has been no net change in position. For every share of stock bought, an equivalent share is sold. A gain or loss is made on the difference between the purchase and sales prices.Studies have shown that the mo ...The Secret Hidden Market Most people believe that the majority of money exchanged daily by the banks, insurance and brokerage houses happens on the well known Dow and S&P. The truth is, by far the most money that exchanges hands occurs in the currency markets, and dwarfs the amount exchanged on the Dow and S&P. Most people have heard of the Forex market, but have no kno ...FOREX Trading Systems – How To Pick One For Huge Gains FOREX trading systems are big business now as the internet allows anyone to use one and make big profits.The question traders need answered is - what do they look for when they buy a FOREX trading system to locate the good FOREX systems from the losing majority.This article will give clear, concise, tips for picking a FOREX trading ...NASDAQ 800? In November of 2000 when the NASDAQ was trading at 3000 I wrote in this column that the NASDAQ Index would fall to 1500 and I got lots of heat for saying it. Microsoft had fallen from $129 to $60 per share. You know where they are today.The talking heads on CNBC-TV and many of the radio stock experts are convinced we are headed back up as ...Forex Trading - Too Much of a Good Thing? When entering the world of Forex trading, you are beginning to enter a market that is very unpredictable and sometimes volatile. In foreign exchange trading, all trade is conducted in real time and this is what can cause a lot of the risk. This can make trading somewhat of a challenge, even for those who have the benefit of experience on their s ...Forex Mini Account - Am I Eligible? If you were just learning about Forex Markets a good idea for you would be what is called the Forex mini account. The mini account is also great for those who want to start off with a fairly low investment. A mini account can be opened with only $250 while a regular one has to involve a minimum of $2,500. The option of the Forex mini account is ...Investing in the Currency Exchange An often-overlooked form of investment is the act of investing in money directly… this is often done via the currency exchange, and can take a bit of skill and luck to get the hang of. Once you've gotten used to the intricacies of the of the currency exchange, however, you might find that it is one of the more interactive and lucrative forms of ...A Look at Online Forex Brokers An online forex broker is a firm that facilitates retail trading using Internet technologies. Global Forex Trading (GFT), one of the popular online forex brokers. It provides retail traders with a free demo trading account, allows users to open a live account, gives live help, provides software called DealBook FX 2, and allows viewing of accoun ...Forex Trading: How to Setup a Solid Workstation? IntroductionAt first glance, it may not appear that important, but you will come to appreciate the wisdom of ensuring you have all of the tools necessary to make your currency trading experience a positive one.Work Station LocationChoosing the right place for trading is your first step. Be s ...When Should You Sell? When it comes to the stock market, buying is easier than selling. One of the hardest things to do is know when you should sell.No matter what, you need to know what you are looking for in your investments. There is a lot that goes on in the stock market. You have to not only consider how much you are making or losing, but the tax ramifica ...Forex Trading - A Basic Overview Forex trading is becoming more popular as time goes by. Perhaps you have heard of forex trading, or heard things such as "the dollar fell sharply against the yen". Not sure what all this means? Here is a basic overview of forex trading.The foreign currency exchange market (forex) is the largest market in the world. Much larger than th ...A Guide to Currency Trading Though it may seem a bit strange at first, there is money to be made in the trading of money. Individuals who carefully monitor the exchange rates of different currencies can use currency trading as a source of income akin to stocks and bonds… converting their money from one currency to another, waiting for the exchange rate to shift, and then c ...Why Choose Forex Trading Over Stocks Trading Forex trading holds significant differences to stocks trading. Understanding these differences will aid a trader in deciding the right market to enter. Forex trading itself has several advantages over stocks trading and is ideal for the beginner and individual small investors.1. Low Transaction Costs for Forex Trading. There are no h ...A Guide to Mutual Funds If you've been thinking about getting into investment but aren't sure what you should invest in, you might want to consider looking into investments in mutual funds. These funds are designed to provide a diverse investment opportunity for the shareholders who have purchased shares in the fund. They can be used as an easy way to create a diverse ...New to Investing? Simple Guidelines for Success A financial advisor and friend once told me, “It doesn’t matter how good of job someone has, if they want to acquire wealth in this life, at some point they are going to have to invest in something.” Investing is something most people will do during their lifetime. They may invest in real estate, life insurance, stocks, bonds, mutual funds or a ...
|
