A Primer for How to Short Stocks

Laying down some rule for those of you who want to short the market.

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Everyone wants to try shorting sometime. Getty Images/Yasuyoshi Chiba/AFP Creative

Shorting stocks is a higher risk game right now, especially when you consider that the Government and Federal Reserve (private bankers) are trying to prop the stock markets up during this election year.  So right off the bat, the odds are against you if you are shorting in the near-term.

Additionally, from a historical perspective, the stock market has trended higher for over 200 years, and the average period of a Bull Market is 3.5 years while the average length of a Bear Market is 1.5 years.

Again, on a longer-term basis, the odds are against you if you are shorting.

Furthermore, when you short a stock, because a stock price can go to infinity, you can lose all of your money. But if you short a stock and it falls and you are making money, the amount you make is finite, or limited, because when the stock price goes to $0 that’s it….

Finally, the Government and Securities and Exchange Commission (SEC) can change the rules of the stock market with a stroke of the pen.

In 2008, the markets were falling and the SEC ruled against short selling financial institutions and other significant companies….so you can be making money “shorting” and overnight have your butt handed to you because the “Powers That Be” decided you are un-American by making profit off of the "misfortunes" of others.  (By the way, Investment Banks were allowed to short all stocks – because they own the rule makers).

And  have you ever heard of the SEC halting “buying a stock” because it was going up too fast? Nope. Again, the field of buying long and selling short is tilted in favor of buying long.

SHORT SELLERS BEWARE...!!!

That being said, when I am going to short a stock, this is what I look for:

  1. The overall stock market is overbought, in a trading range, or trending down, not breaking out or oversold, and
  1. The stock I am shorting--its industry is in a downtrend, and
  2. The stock I am shorting has entered a downtrend itself.

What time frame am I talking about for each? It doesn’t matter, just make sure if you are a short-term trader that the short-term trends are down, and if you are longer-term the longer-term trends are down (determining trends is another topic).

I look for certain chart patterns (and these apply on any timeframe). I want to see the stock first move in a “false” direction, breaking out to the upside, then reverse and hit a new low for the day, then when it tries to bounce back and rally towards that daily high, I enter the short position as it approached that high and place a stop from .01 to .20 cents above that day’s high price.

Right now as the DOW is hitting multi-year highs the idea of short selling may be the last thing on a traders mind.  That is especially true these days when you can “buy long” an Exchange Traded Fund (ETF) that shorts an industry or market – and thus you don’t ever have to learn shorting techniques. There are advantages and disadvantages to buying short-side ETF’s, but that’s also a topic for another day.

Short selling is one of the hardest things to do in trading and no matter how you try to quantify it, it still is more of an art than a science.

 With that said, in times of a down-trending stock or market, it is nice to have this tool in your arsenal and be able to make money with it instead of sitting in a losing long position or in cash.