First I want to say that for most people Short Selling Stocks is not a good idea. In general it can be much more difficult to short stocks than it is to buy and go long. I will give you three major reasons this is so:
1) The long term trend for the markets has been UP. If you are short selling you are going against the long term trend. In general most stocks follow the trend of the market.
2) You cannot make more than 100% on the trade. A stock can only go to zero, HOWEVER a stock can go up many multiples, 200% 300% and more are possible when you go long a stock.
3) Short covering rallies in a stock (or the markets in general) tend to be fast and furious and can take back any gains you had in a heartbeat.
That being said, Short Selling Stocks can be a profitable addition to your Swing Trading Strategies. I will give you my strategy for short selling.
1) Look for stocks that have broken down on HEAVY volume, this will usually be the result of a bad earnings announcement. The key here is a heavy volume sell off and the stock has plunged at least 15% to 20% usually over the course of a day or two. It is best if there is a large gap.
2) Once you see a stock get crushed like this, you need to be patient. Put the stock on your list of potential shorts and keep an eye on it waiting for the opportunity to get short. Here we watch as AMZN slowly rallies forming a classic “Wedge” formation. This is a bear wedge forming. A breakdown from it is our entry.
3) The setup is almost complete, we now just patiently wait for the stock to break down from the wedge to get short. Your stop loss will be just above the wedge around $380.
4) The stock has now broken down from the wedge and we should now be short at around 375 with stop at 380.
At this point we just trail a stop as AMZN drops in price. Our target in this case is a matching price move of the first breakdown in price. In this example, price broke down from 400 to 340 or about $60 so we would look to exit at least half our position at 320. (380 – 60)
If you decided to hold onto the other half of your position then you should put a stop at 340 to exit the other half. As it continues down we just move our stop above the next resistance point.
Here are some things to keep in mind when shorting stocks.
Don’t short a stock based on valuation. Just because a stock has a high price to earnings ratio (P/E) is not a good reason for shorting a stock. Do not use valuation metrics to determine if the stock is worth shorting.
Avoid momentum stocks. These are stocks that have risen much too far in price based on fundamentals that seem made out of rumor only. The stock gets lots of media attention for its quick but large run-up, leaving many to believe the stock just has to drop. It doesn’t. If you short the stock, the upward rise will probably bankrupt you just before the stock finally tumbles.
Don’t short a stock above a rising 30-week (150-day) moving average. The rising simple moving average means upward momentum is still on the side of the bulls.
Never short a thinly traded stock. I’d avoid a stock with fewer than 500,000 shares trading daily.
Its Best to avoid shorting stocks in a strong industry. Preferably you want the market, industry, and stock to all show weakness. If any of the three are strong, you increase your chances of picking a loser.
Never short a stock without a protective stop. This goes for whether you go long or short, ALWAYS use a stop loss.
So how do you find candidates for short selling? The best way I have found is to use FinViz.com, run a screen to look for stocks having “Unusual Volume” and set a filter for stocks over $50. I prefer to short stocks at least $50 or more so that there is some room for it to drop.
If you have any questions on short selling, feel free to contact me.
The stock picking service that I recommend for short selling stocks is: Jason Bond Picks Review
Regardless of which Stock Picking Service you use or if even if you choose to go it alone, please download my free eBook: “The 7 Habits of Millionaire Traders”
You can read all my reviews on stock picking services here:
If you are looking to open a brokerage account or looking for a better one, I wrote some reviews of brokers I have used and currently using.
OptionsHouse Review (Currently Using)
Scottrade Review (Used when I first started)
– Robert Walsh