Short selling has been a popular trading strategy for more than a century, allowing many to churn a large profit consistently.
However, short selling is not easy, and it is important to have a good strategy in place in order to truly become profitable, and minimize risk when short selling.
When short selling is done right and the proper knowledge is implemented, it can be one of the most consistent trading strategies.The following are six tips for navigating short selling restrictions and opportunities that are certain to give you a better chance of success in the world of short selling when implemented.
1. Pick Stocks Trending Down
One of the biggest mistakes made by short sellers with little experience is trying to pick stocks that they assume have reached their peak. It is true that the market fluctuates, and extreme rises may come back down, but trying to bet on a winning stock is a game you do not want to get involved in. There is no telling when a stock is going to come down, and short selling a stock that is trending up is a very dangerous strategy.
Instead, it is better to focus on stocks that are trending down. Of course, selling a stock at its lowest price is not a good strategy either. Rather, finding stocks that are trending downwards and being able to provide sufficient evidence as to why the trend is likely to continue gives you a good chance at being accurate much more often than predicting a sudden change in a trend upwards.
2. Consider The Industry
It is also important to view the industry and market as a whole, instead of simply looking at each individual stock as its own entity. By considering the strength or lack thereof of the industry of a stock, you give yourself a much better chance at predicting trends and locating low risk stocks to short sell.
If a stock is trending down, but the industry of that stock is doing very well, there is a chance that the specific company that is not performing well may recover. On the other hand, if a stock that is trending down in a market that is also trending down, then it is far less likely that a sudden recovery is going to take place.
Considering the industry of each stock being considered may take extra work and cause you to rule out stocks you otherwise feel confident in, but in the long run it is going to save you from a lot of bad short sells.
3. Plan Your Stop in Advance
When a stock does not perform the way we hoped following the sell of a borrowed stock, it can be incredibly frustrating. In these moments, you have two choices.
The first choice is to wait and hope the stock changes course downwards so that you can buy back the stocks and turn a profit, or at the least try and break even off of a bad deal.
The second option is to stop and sell early before you dig yourself in a massive hole when it comes time to buy back the borrowed stocks.
Practicing patience when a short sell does not perform the way one had hoped can be beneficial. However, it is incredibly risky and can lead to a large loss all at once. It is important to remember that even the short sellers still fail on many of their stocks, so it is good practice to have a stop in place in advance to avoid losing too much off of one short sell.
4. Resist The Urge for More
The desperate desire to hold off on the sale of a stock that does perform as was expected when when the shares were sold, can lead to massive losses.
One of the biggest mistakes rookie short sellers make is waiting to buy back on a short sell, hoping to gain a large profit on one fell swoop. What often happens instead is the stock quickly rises out of nowhere, in many cases caused by other short sellers.
It is best to sell earlier rather than later in order to avoid a sudden rise in the stock’s value, which can cause a dead cat bounce in which you to lose out on all of the profit gained up to that point.
5. Avoid Very Expensive Stocks
Many new short sellers often try to trade expensive stocks thinking they have to come down in value and create a large profit when they do so.
However, this is often not the case. What tends to happen instead in many cases is the expensive stocks continue to become more expensive, especially if they are already trending upward.
An expensive stock suggests that a business is successful, and it is risky business betting against a successful company. In a similar fashion as betting against a very good sports team is often not a winning strategy, short selling successful stocks is not usually a good, long term strategy to implement.
6. Limit Your Risk
There is often such a thing as “too good to be true” when it comes to short selling. There are certain to be times when short selling that you come across a stock that “just has to drop.” However, it is best to not work off of large risk and large reward stocks as they can lead to huge losses.
When short selling, it is true that the volatility of a stock should play a large role, meaning how much a stock fluctuates in value should certainly be considered. However, it is often better to stay with stocks that have a lower volatility, although the stocks with higher volatility can often be much more tempting.
By avoiding high risk and high reward stocks, you can avoid a large sudden loss that wipes out your bank account completely.
If you have had success with short selling stocks, leave a comment and share your experience, as well as any helpful tips you may have in the section below.
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