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'SHORT' Is Not a Four Letter Word
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Tom Ventresca
Market Edge.com |
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When the big bad bear takes hold of the market, shorting stocks can be a profitable strategy.
Trees don't grow to the sky, what goes up must come down,
if you inhale you must exhale and stocks don't go up forever. So what is one
to do when the big bad bear takes hold of the market? Short 'em baby. Contrary
to popular belief, shorting stocks is not un-American nor, if done properly,
any more risky than buying stocks. Plus, when you get it right, a good short
can fall much faster than it takes for a typical long position to rise.
The following procedure should be adhered to when
developing a successful short-sale strategy.
- Market Trend: Seventy percent of stocks will
typically follow the market's trend. Market Edge's 'Market Posture' has a track
record dating back to 1974 of forecasting the market's intermediate term
direction as measured by the DJIA with better than 80% accuracy. Therefore, in
order to have the odds on your side when shorting stocks, it is important that
the 'Market Posture' be regarded as bearish.
- Identifying Short-Sale Candidates: The
temptation when looking for short sale candidates is to go after the stocks
that have been the recent high flyers. This can be a very risky proposition.
There is usually a good reason why a stock has been an outstanding performer.
So even if the market tanks, the likelihood of the high flyer crashing to the
ground is slim. If you must chase a high flyer, wait for it to break down
before initiating a short position. You will not get the full ride but once
they break, there is usually plenty of room on the downside.
A more conservative approach is to find stocks that have
been market laggards during the previous bull phase. The logic is simple. If
a stock can't perform during the good times, what will it do when things get
rough? Also, if the assessment of the market's trend is wrong, the likelihood
of getting hurt is greatly reduced.
- Timing the Trade: Once a short sale candidate
has been identified, the next step is to time the entry point. This is best
accomplished by waiting for an overbought condition to develop based on the
stochastic oscillator, a technical indicator with values that range from 0 to
100. When the stochastic oscillator is between 20-80, a neutral condition is
in force. Readings above 80 denote an overbought condition.
- Exiting the Position: Whenever any of the
following events occur, the short sale should be closed: the market trend
reverses to bullish, the stock violates its buy stop, a target is reached or,
for a short-term trade, the stochastic indicator falls below 20 indicating an
oversold condition.
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There are several prerequisites that you need to be
familiar with when shorting stocks.
- Permission to Short: Before you can short a
stock you must get permission from your brokerage firm. If your brokerage firm
doesn't have any stock, they will have to borrow it from another firm so they
can deliver it to the buyer. If there isn't any stock to borrow, you can't
short the stock. If you can't borrow any shares, you don't want to short it anyway.
This indicates a situation where there is a large short position in the stock
and increases the odds that a short squeeze could develop.
- Uptick Rule: A SEC rule that restricts when a
short sale may be executed. This rule
is intended to prevent destabilizing the price of a stock when the market price
is falling. A short sale can be made only when one of the following situations
exists: 1) The sale occurs at a higher price than the last trade or 2) there is
no change in the last trade while the previous trade took place at a higher
price than the price that preceded it.
- Margin Requirements: Usually margin
requirements for short sales are the same as a long position purchased in a
margin account, 50%. Unlike a margin account, there is no interest charged and
in some cases you may receive an interest credit. If you short 1000 shares of
a $20 dollar stock, you will have to put up $10,000 in either cash or bonds and
execute the trade in a specified short-sale account.
In short, selling stocks short is not for everyone. However, during
extended bear markets it can be a very profitable strategy for aggressive
traders.
"Tom Ventresca will be available for questions until Monday, February 14. Don't miss this chance to ask your questions using the below form. |
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