| What does it mean to short a stock? | | | | years although this is not always necessary. Stocks |
| This means that you borrow the stock from your | | | | such as the mortgage lenders (LEND & CFC) |
| broker to sell to a third party. The idea is to buy back | | | | have built many bases since 2002 and have run up |
| the stock at a lower price, returning the shares to your | | | | several hundred percent. Home builders also fall under |
| broker while leaving the remaining cash in your account | | | | this category but have not made our shorting lists as |
| as a profit. Put another way, a short seller does not | | | | of yet. They have been showing some red flags but |
| own the stock before they sell it. Instead, they borrow | | | | support has been noted at or slightly above the 50-d |
| it from another investor who already owns it. At a | | | | moving averages. |
| later date, the short seller buys back the stock they | | | | Additional criteria for shorting candidates will be |
| shorted and returns the stock to close out the loan. If | | | | decelerating earnings and sales and a relative strength |
| the stock has fallen in price since they sold short, they | | | | line heading down. Basically take the characteristics |
| can buy the stock back for less than they received | | | | that we use for long positions and reverse the criteria |
| for selling it. The difference is your profit. | | | | to develop a list of possible short candidates. Even |
| Short selling is a transaction made on margin. This | | | | familiar chart patterns can be used to spot shorts; the |
| means that you must open a margin account to sell | | | | reverse cup shaped base, the head and shoulders |
| short. Most online brokers allow you to open a margin | | | | pattern and/or the flat base with a stock breaking out |
| account if you qualify according to their rules and | | | | to the downside on above average volume. Industry |
| regulations. Criteria related to minimum balances and | | | | groups that are becoming weak or are showing |
| cash reserves may apply. You will sign an agreement | | | | multiple stocks falling and breaking through key trend |
| with your broker to open a margin account, this | | | | lines should be noted on a watch list. If one stocks |
| agreement says that you will maintain a cash margin | | | | looks like a short candidate, look for additional sister |
| or pledge your stocks as margin. (Note: Call your | | | | stocks that may have the same set-up. Remember, |
| individual brokers for additional questions that you may | | | | stocks usually move in groups whether they go up or |
| have). | | | | down. |
| Shorting can be difficult even during a bear market. | | | | I tend to look for stocks that are below both the 50-d |
| The conditions must be exactly right for a stock to be | | | | and 200-d moving averages. Once they slice through |
| considered a short. Just because a stock looks | | | | both of these lines, I then look for a strong down-trend |
| overvalued or high doesn't mean that it is time to sell | | | | and a failure to break above the 200-d moving |
| this stock short. As I have said before, what looks high | | | | average. This is my ideal time to short a particular |
| to one investor may still be low to another. Two things | | | | stock. |
| to take into consideration would be dividends and thinly | | | | Always have a sound exit plan in place with a |
| traded stocks. A stock paying a dividend must be paid | | | | predetermined stop loss to protect your capital. We |
| by you the short seller when this position is on. Low | | | | typically use a 7-10% stop loss for our long positions |
| volume stocks can be very volatile and market | | | | depending on the market strength but I would advise a |
| makers and money managers can run up the price | | | | larger buffer for short candidates. A stop loss placed |
| quickly crushing your short play and adding to your | | | | 10-12% from your sell point would be ideal as most |
| overall loss. | | | | stocks have a natural tendency to go up or contain |
| If the stock rises above your sell price, eventually you | | | | volatility near the shorting sell point. |
| will have to cover your short for a loss. If you have not | | | | Shorting stocks can be more difficult to learn than |
| placed a stop loss, the stock can continue to go higher | | | | buying stocks because a whole new set of rules and |
| as your portfolio heads for disaster. Theoretically, a | | | | bearish short patterns must be learned, on top of your |
| stock can rise infinitely, meaning your losses can rise | | | | buying rules and chart pattern skills. Shorting can take |
| infinitely. Imagine shorting NVR at $200 a share | | | | many more years to master and can provide a |
| because you though it was overvalued, only to see it | | | | shorter window of opportunity as bear markets |
| go to $700 per share. I am sure this type of trade | | | | typically don't last as long as bull markets do. No |
| would wipe out or leave a big dent in anyone's | | | | matter what strategy you develop with shorting or |
| portfolio. | | | | buying long, you must always stick to strict sell rules. |
| Many great shorting opportunities come from the | | | | Never argue with a position that goes against you, |
| same small and mid cap stocks that were once high | | | | emotions and pride mean nothing in the market, |
| flyers in previous months or years. For example, | | | | especially in the short market. Sell all losers immediately |
| TZOO and DCAI were high flyers in 2004 before they | | | | before they devastate your portfolio and your |
| became red flags and shorting opportunities. Even | | | | confidence going forward. |
| large cap companies such as eBay, SBUX and HD | | | | The next article from this two part series will detail the |
| can present shorting opportunities at certain points. | | | | strategies or reasons why you may want to short a |
| Ideal shorting candidates will have built several bases | | | | stock and a few examples of how shorting stocks |
| over a long period of time resulting in faulty late stage | | | | can benefit a portfolio during bear markets or sideway |
| bases as the stock starts to fall. We look towards | | | | corrections, similar to our current situation. |
| stocks that have built four or more bases over a few | | | | |