A skill every trader should know is shorting the market. Markets don’t always go up. Sometimes they move down or trade sideways. Knowing the different ways to capitalize on market moves allows traders to profit no matter which side has control. Watch our video on how to short stocks. The market is a tug of war between the bulls (buyers) and the bears (sellers). The market must make corrections. This in turn, means that stocks move down in price. In fact, traders should know how to go short as well as long. This way you’re not stuck waiting for the market to change direction.
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What Is Shorting the Market?
Shorting the market consists of taking a bearish stance on the market rather than a bullish one. You believe that the market is going to fall so you take a short position with your broker on a particular stock. You sell high creating a negative position, then you buy low to cover and keep the difference in profits. Short selling is capitalizing on the a stock’s fall. It allows traders to sell a security they don’t own. In essence, traders borrow a stock from their broker at the current market price.
Then the trader covers; which means they buy the stock at the current market value. The loan is then repaid to the broker. The profit is the difference between the sale price and the purchase price.
This can seem confusing as one might think by covering a short position they now own the stock. It’s like loaning a car. You don’t own the car when you’re done with it. Shorting the market is a lot like that.
Anyone paying attention to the current market situation has seen that it was rising for awhile. The past few months have been full of indecision. There have been a lot of red and green days.
On the negative side, the back and forth has affected the price of stocks. On the positive side, shorting the market allows traders to take advantage of the dip in price occurring.
You may have heard people talking about buying the dip. Shorting and dip buying are a lot different from each other.
Brokers and the Scanners
When shorting the market having a good broker is paramount. Some brokers don’t have shares to short. This in turn has you sitting on the sidelines waiting for the bulls to take over again.
If you’ve ever been stuck waiting you know how frustrating it can be. Thinkorswim has shares to short on some stocks but not all. It can be hard to find shares for stocks. Don’t discount them though as they do have stocks that are easy to borrow (ETB). You may just have to look for them.
A great broker for shorting is Interactive Brokers. They have a niche in the shorting arena. In fact, you can find a lot of shares to short on many different stocks through them.
Now that you have a good broker, having a scanner that finds shares is a good investment. Brokers like thinkorswim have stock scanners available to use. You can customize the scanners for shorting the market.
Another fantastic scanner is Trade Ideas. This scanner is one of the best out there for any kind of play.
Candlestick Patterns
Traders don’t go in blind when shorting the market. Patterns and candlesticks are the name of the game. Large patterns such as descending triangle patterns can have a long term impact when shorting the market.
Head and shoulders patterns or cup and handle patterns change the way a trader would trade a stock. Hence everyone needs to know patterns and what they mean.
Patterns break down all the time because bullish and bearish patterns form within each other. You need to be able to see the patterns within the patterns as well as know what candlesticks mean, especially when trading penny stocks.
For example, long legged doji candlesticks and hanging man candlesticks make up patterns but have different meanings. Candlesticks give warnings to breakdowns or breakouts.
Does Short Selling Hurt a Company?
- Short selling doesn’t hurt a company in the short term. Shorting is a normal process of buying and selling stocks in the market. If the overall sentiment long term becomes bearish and the shorts get their way with keeping price action down then the stock might have a tougher time recovering longer term.
Technical Analysis
Using technical analysis when shorting the market gives confirmation to moves. Support and resistance play a huge role in trading. Shorting the market means you’d want to sell at resistance buy at support. This is the opposite of what you hear a lot which is buy at support sell at resistance.
Not only do candlesticks provide support and resistance but moving average lines do as well. The simple moving average formula along with the VWAP trading strategy play a big role; especially when day trading.
Moving average lines like exponential moving averages play a large role in buying and selling also. It’s important that traders know and pay attention to these indicators.
If you need more help, take our day trading course.
