Short-selling stock must be pretty profitable if some traders are giving themselves huge paydays doing business this way and incurring the wrath of big businesses, right? Not necessarily. It takes more savvy to go short than long, and your risk is greater. Here is the technical analysis, along with money management and psychological reasons you should steer clear of shorting shares.
Here is a look at technical signals that warn you to venture away from shorting.
1. Beyond its 30-week moving average
If you use weekly charts, the 30-day moving average, invented as a trend tool by Stan Weinstein, should be the line you do not cross. This is because this average will provide you with the same information about whether a stock is in a bull or bear market as the 200-day moving average for daily chart traders. At times, a stock will go above its moving average, shake off weak gains, then rally again. It becomes too tricky at this point to short with any certainty. Besides, you can use moving averages in other strategies and win.
2. Beyond its 200-day moving average
This is the same line in the sand as above. The only difference is that this indicator is considerably more popular. As the 200-day average represents 50 more trading days than the 30-week average, it will lag behind the 30-week average somewhat. Do not go short when the shares are markedly below this 200-day moving average.
3. Avoid shorting when the stock is in a clear uptrend
Does the stock have higher highs and higher lows for the last three swing points in a row? Although you can profit from any kind of trend in theory, pulling off a successful short in a clear upswing trend has to be one of the hardest maneuvers. The risk is great even if the stock is hitting the resistance line.
4. Steer clear of shorting volatile stocks
Biotechnology stocks are normally the ones to make a profit from when stock prices are bobbing up, down, and sideways. You might make money if you time it right, but is it really a good idea to opt for this level of high risk exposure in your strategy when other trading strategies that are easier to execute – and safer – abound? The problem with biotechnology stocks in particular is that they fall or rise unpredictably on the back of any industry-related reports, such as new research or clinical trials.
5. A robust bull market means you should run clear of short selling
Selling short in a bull market versus selling long is not only exponentially riskier, it’s the equivalent of trading with the wind at your back versus trading in headwinds. Yes, it depends where in the bull market you find yourself, but statistically you are more likely to lose money by far if you short sell.
These trading tips underscore that trading isn’t only about choosing the right strategy; it’s about doing so at the correct time and choosing one that fits into your budget. Otherwise, it is much harder to weather setbacks.
6. Stay clear of stocks with strict margins
Attempting to short sell highly volatile stocks usually means you are forced only to use cash you have on hand as the margin requirements imposed by brokers are understandably strict. Should you walk right into a rally, you’ll probably get a margin call. Then, you need to add cash or close out, often in a losing position.
7. Using almost all of your margin
Let’s say the margin is relatively loosened; you may be wondering why shorting here is a risk. Many traders use 150% or all of the 200% of marginable equity and have found themselves in dire straits more often than not. Every trader needs to be resilient, but there is a range of resilience that will affect your actions as a trader.
8. Can you cope with the notion of unlimited risk?
Unlimited risk is the exact game you are entering into when you short. There are times when the market can and will go against you for substantial periods.