Looking to dips your toes in the short waters? Perhaps you’re looking for a new edge in your trading? Surprisingly, short selling stocks is really not that different from attempting to go long. If you’re looking for stocks to short, keep these five golden rules in mind before you jump right in. Then you’ll be safely short selling.
How to Find Stocks to Short
- Do you know how to find stocks to short? What is short selling? It’s taking advantage of a move down. You’re borrowing shares you don’t own from a broker. As a result, you need a broker that allows short selling. And you’re going to need some good trading rules. So let’s get into rules you need to follow.
Thou Shalt Sell Short Only Those Stocks That Are Trending Down
If there’s one thing I know for sure, it is this: the trend is your friend. It shows you the hard truth, even if it doesn’t tell you. You know in your heart of hearts in the stock you shorted, the momentum is shifting.
You need to have the courage to listen, put the ego aside. If all indicators are screaming a pop is coming – think 9/20, VWAP, 50 SMA crossover to the upside with a strong volume surge – get out and get out now! I get it; it’s nice to dream of nailing a stock that is ridiculously overextended and riding it all the way down. But if I must give one piece of advice, do yourself a favor and wait.
Since trends, once in place, tend to continue, you’d be wise to heed the advice of your friend. Put the odds in your favor. Wait until the reversal is confirmed, then jump in – you can thank me later for this.
Thou Shalt Short Sell Only When There Is a Catalyst Driving the Move
Once again, like the first, this rule ensures that the odds are forever on your side when you short. Like a hawk scanning for their prey, momentum traders will scan carefully for catalysts.
Like a hawk swooping in on their prey, they strike when the time is right. Many have their ear to the ground, looking for companies that are undervalued or flying slightly under the radar.
Perhaps looking for companies about to release a new product. Catalysts in their purest form are anything that will cause a drastic move in a stocks price.
Typically, this comes in the form of new, unexpected news. A lot of investors and rightfully so, look to capitalize on these short-term opportunities.
On the other hand, you should fear a significant move in price without a catalyst like a plague. What comes to mind here is the “pump and dump.” – Illegal by the way.
Typically the stock is promoted as a “hot tip” being “the next big thing.” Someone is stirring up the pot trying to churn interest in the company without a valid reason to do so.
And once everyone who didn’t want to miss “the next big thing” has bought in, the shareholders dump the stock. And along with it goes the price.
Consider yourself warned or you could be the prey.
Thou Shalt Sell Short Only When the Stock Has a Long Way to Fall in the Arena of Public Opinion.
Humans are a funny bunch, in my opinion. And it still amazes me to this day how quickly the mood or sentiment of the public can change just by simple news.
Take the 2018 Facebook (FB) privacy scandal, for example. December saw an all-time low of $123.02, down almost 50% from July. If you caught it on the downside when news broke, could have ridden it all the way down.
Alternatively, buy put options if you don’t have the capital to purchase the shares straight out. Now everything that goes down comes up. So you could have ridden the call train on the way back up. Last month it hit a high of around $200.
Even more astonishing is when that news is false. In 2013, a tweet about two explosions in the White House wiped out more than US $130 billion in stock value in a matter of minutes.
Even more astonishing, the Dow Jones Industrial Average dropped about 143. 5 points. In a later news release, AP said its Twitter account was hacked.
Rumors have a nasty way of lingering, long after the dust has settled. And the fall from grace can be long and hard.
Your job as a short-seller is this. Find these falling stocks and short the heck out of them.
The Risks of Stocks to Short
When you “go long” or buy a stock, you hope the price will go up. The most you can lose is the upfront cost to enter the trade. But, your profits are unlimited if the price keeps going up and up and up. In other words, there’s no ceiling you can hit.
On the contrary, when you short sell a stock, you hope it falls to zero and hits the floor. But what if the tides turn and the prices rise? Without a ceiling, there’s no limit to the amount you can lose.
Luckily though, this can be avoided with tight stop-losses and proper risk management. We show you how here in our risk management video.
Thou Shalt Not Trade on Margin or Use Leverage
Unless of course, you’re a seasoned expert. If not, you’ll quickly be a seasoned gambler. To summarize, margin allows you to borrow money from your broker so you can place larger trades.
With margin comes to leverage, or, the ability to enter larger trades. Say, for example, you had $25,000 in your trading account with 2:1 leverage. In the trading world, this means even with only $25,000; you would be able to purchase $50,000 of stock.
I don’t think I need to explain the dangers here. You can quickly see how deep the hole you can dig is.
For those of you who know me, you know I have a bias towards short selling. Mainly because I find it easier to spot stocks that are overextended and primed for a reversal.
That’s my edge. For some reason, I get hesitant and don’t want to jump in a stock that is riding up. Even if the indicators are telling me to. But that’s me, and that’s what works for me. So, if you want to find your edge, join us today!