Are you a victim of massive losses in the recent past due to the stock market crash that has written about in my previous post? If yes, then it’s must be an embarrassing event for you and everyone. And now what you eagerly want to know is how to short a stock and make money by shorting a stock.
Yes, you can find a lot of insider techniques that I am going to explain to you in detail in my article. If you know the techniques or learn a few of the bear market strategies, you can make tons of money. Sound interesting, right? I name these combined techniques as the Heed Technique.
In this article, you’ll learn some proven trading techniques that can bring you massive success going short. What you will need is to gather some simple technical knowledge such as Moving Averages, RSI, simple chart patterns, and so on.
I learned some of the strategies in an online workshop organized by SAMCO (one of the leading discount brokers in India). And I have improvised them and made a unique strategy that I termed ‘The Heed Technique’ and earn my day-to-day cash flow.
Today I will discuss elaborately some of the untold secrets by which you’ll be able to beat the market and earn your living. Employing these tools advantageously in your trading is the real secrete all about.
After getting a fair amount of basic knowledge, what you need to do is just follow the Seven Steps Process and Three Steps Bear Setups. These step-by-step techniques in simple ways can bring you real money by short selling. But before this, you need to learn what short a stock is.
What is a Short Sale Stock?
Shorting a stock is a unique trading method where you borrow shares of stock from a broker and then sell them. You short sale stock with an expectation that the price will continue to fall. You’re then buying to cover the stock at a lower price and profit from the price difference. And after buying back, you return the borrowed stocks to your broker and call it a day.
How Does a Short selling Work?
If the price does not fall according to your expectations, it will invite you big trouble. And you are still responsible for buying back those shorted shares and returning them to your broker. If you are a traditional investor and can’t cope with the mental stress that develops during the short selling, this method is not for you. If done correctly, short selling is highly profitable trading. Shorting has become famous since the days of legendary investor Jesse Livermore.
Short selling is a very intuitive trading technique for speculators, hedge fund managers, and individual investors who are willing to take substantial risk of capital loss. Short selling stock is selling stocks or derivatives without owning and then buying them back.
Shorting is mostly done in the derivative segment such as stock & index future. It’s a specialized trading technique and not an investing strategy where you follow ‘buy and hold’ strategy by keeping your long position open for a longer duration.
As I mentioned earlier, your basic technical knowledge is an added advantage in shorting a stock. So, before starting, you need to have some amount of basic understanding of price chart, trend-line, moving average, and a few other technical indicators. If you do so, this article will make a lot of sense to you.
How to Short a Stock and its Advantages
If you take long positions during your trading activities, you can only profit when your stocks increase in price. If you are bearish, you don’t trade. You may have to stay aside for months or even years during the entire bear market cycle. Short selling breaks that barrier. It likes two-way traffic. You earn in bull as well as a bear market. When you learn the art of short selling, you start looking for stock short sale opportunities.
Also, you need to know that the bull market sustains around 75% of the time whereas the bear market has a very limited time-frame of around 25%. And to make money by shorting, you have limited time and limited options. So you need to be very smart, fast, disciplined, and should have a proper strategy. This is like gorilla warfare.
Another good advantage of short a stock is that here the competition is less. And it’s a fast track process means the stock price in the bear market falls faster than it appreciates. So your chance of success is far higher. This is because a majority of folks usually are investors and traders in the bull market. So from a profit point of view, the bear has a shorter time-frame to capture profit and bull will have a longer duration to make money.
Motivation and The Intellectual Process:
These are very crucial to consider for short selling if you want to get success in how to short a stock. This process can be categorized into five sub-heads.
*Mental Characteristics: In a short sale, we need to control our emotions, feelings, grid, fears, and risk-taking ability because bear market trading strategies are different from the bull market.
*Control over Inherent Behavior: We assumed that majority of the time we stay in a bull market. That’s why all our investment strategies move around to buy and holds, buy on dip kind of strategies. Our mind usually pre-occupy with a mindset that when a stock price falls or corrects, we need to buy. Hence you need to control that inherent automatic behavior if you want success.
*Belief System: If you want to make money in a bear market, you need to have a proper belief system. You’re often misleading by some conservative phrases like “Why you should never short stock” or “How to short a stock and why you shouldn’t”. If used wisely, short selling can be very profitable in a bear market. So, if you prepare yourself, you can make big money shorting a stock. But need to be on the right side of the market.
*Be Realistic and Not Optimistic: To trade profitably in a bear market, you need to understand what the ground situation is. And you should know how the current economy is doing; extend of grid & fear, and what the company is doing.
Above all, you need to be a realist and not an optimist to get success in short selling. This is because while you’re in investment, you are an optimist by default. But if you’re a trader, you have to be a realist. Whether it’s a bull or bear market, you always need to be on the right side of the market to get success.
*Be Fearful, Not Hopeful: Why I am telling you so? This is because if you trade short, and the price is moving higher you will be in loss. And eventually to your surprise, you see that the price keeps on rising and rising.
But instead of this, if you are holding your short position longer, hoping that the price will come down again, you probably would do a big mistake. And when the price is moving against you, you should immediately take an exit and cut your losses. Why? It’s because the bear market lasts a shorter period.
Why Does Short Selling Seem Daunting?
To be honest, it is the idea of short selling that has scared many traders. They have backend in their mind that short selling is something to avoid. It is too complicated and risky trades. They have created this mental barrier, protecting them from something that can be staying them away from a highly profitable trade.
This is simply because they don’t know enough and don’t know where to start. And once you have made up your mind about something, it can be difficult to change that perception.
Some Technical Terms You Should Know
Relative Strength Index (RSI):
This is one my favorite indicator to adapt in a short sale trading system. When RSI of a stock is in a highly oversold territory say less than 10 for a while, it may surprise you, and your stock bounces back fast. I find this very reliable for fundamentally weak stocks in a bear market. But at the same time you need to check some other reliable trade setups, I will discuss in my post.
Open Interest and Option Chain Analysis:
You need to find out the open interest around the stock before short selling. It tells you whether other investors are bearish on a particular stock. This works superbly in shorting-a-stock trading if you analyze it and apply it correctly.
Option Chain is nothing but an Open Interest (OI) along with other information spotted in an option chain. If you dig it out precisely where the highest OI or Shorting Interest exits in a Call side of the option chain, you can take it major resistance level.
A trend line is a momentum indicator. In our case, it has usually drawn on a daily bar chart as an inclined support line that connects a series of day’s low prices. Whenever the price breaks the line on the lower side and trades below the line, it indicates a technical weakness. But you should not match it with horizontal support and resistance.
Support and Resistance Levels:
Many short sellers plot major resistance areas on a daily chart for finding short selling opportunities. And when daily resistance areas coincide with the highest OI on Call Side of the option chain, you can take it as confirmation to initiate a short sale. Likewise, whenever major support levels harmonize with the highest OI on Put Side, make it a habit to cover your short position.
Daily Moving Average (DMA):
Many traders and investors out there use DMA of several dimensions to initiate their trades. Out of many, I find two moving average-50 DMA and 200 DMA help immensely in my short selling. But the focal point here is that you can’t fully depend on it. You need to check and get confirmation alongside other indicators and patterns as I discussed in my Heed Technique.
Myths about Short Selling: When You should not
*Short sell High P/E stocks: A high P/E stock rightly has a strong fundamentals story and carries the characteristic of a growth story. Hence stay aside from this type of stock for shorting.
*Short sell 52 Weeks High Stocks: Shorting a 52-week high stock is a suicidal attempt to your trading journey. When an up-trending stock is inching higher by making new highs, it might have carried strong fundamentals. So you need to forget about it for your shorting candidate.
*Short a Stock in its Oversold Zone: This is not a good idea to shorting a stock in its oversold zone. Be it a fundamentally good stock, or the worst stock, it often shocks you with its sudden uptrend. So unless you’re sure you need to be careful about going short.
*Short a stock with upright DMAs: Technically this happens when lower degree DMAs remain above higher degree DMAs. I usually plot a few important DMAs like 200 DMA, 50 DMA in the price chart during my shorting. When I see the 50 DMA rests above 200 DMA or 50 DMA make a crossover of 200 DMA, I refrain from short selling.
*Short Sale Stock When Companies Report Bad Quarterly Results: Why I am telling you this? This is because one of the front-liner Indian companies Tata Motors came up with the worst quarterly result in the recent past. It crashed as usual, but it surprised everybody and surged massively on the same day of the crash. Look at the price chart, where you’ll find RSI in the oversold zone.
*Short Sell on Bad News: Many a time, it backfires when you short sell a stock on bad news.
For example, Boeing’s share price during March 2019 was crashed when China, Indonesia, and Ethiopia grounded their Boeing 737 Max8 after two of their aircraft crashed in Ethiopia and Indonesia. Despite strong order books and decent fundamentals, Boeing at NYSE crashed sharply losing its 13% price value and recovered 50% of loss quickly.
If you look at the price chart at its recent time bottom level, you’ll notice that RSI is in the extremely oversold zone. And shorting a stock in its oversold zone is pretty dangerous. So, bad news will not always bring you an opportunity to short selling.
Identifying Sectors and Stocks: The 7 Steps Process
Currently, we’re in a developing bear market and not in a bull market. I am going to explain to you all these seven steps process to identify sectors and stocks. If you follow these seven steps process and the three bear setups that I am going to explain to you later, you’ll have in your arsenal one of the most powerful bear market trading strategies.
None of these strategies you have ever heard about and no one is going to share you this top secret. This is the secret, the hedge funds managers practice to make tons of money by short selling.
What is the Seven Steps Process?
*Always Short Sell during Developing Bear Market and not in the bull market. This is very crucial to short trading success.
*Major Indices (such as Nasdaq or Nifty) have to show definite weaknesses. (In bear phase)
*Check for prices below 200 DMA (Weak stock for being in a bear cycle)
*Check for Lower Tops and Lower Bottoms in prices. (As per Dow Theory)
*Check for relative weakness to identify stocks. (Compared to Index chart)
*Check for RSI of the weak stocks in the overbought zone.
*Check for highest call writing of strike price in Option Chain
*Check for stocks that fail to sustain above 50 DMA or 200 DMA
Profitable Bear Setups:
Linda Raschke once said “All you need is one pattern to make a living! Learn first to specialize in doing one thing well”
a-b-c Pattern (Elliott Correction pattern):
Bear Setups: Breakdown Pattern:
During the world ware-II crisis in 1914, Jessie Livermore made a whopping $80 million (in today’s valuation) by shorting the market. No one in the modern stock market history had ever made this amount of insane money just by going short. But if you can earn a fraction of this big money in the bear market, you can make a living out of this.
Your fund manager or mutual fund manager won’t go short. The majority of traders don’t know the art of short selling. Many people are already out of the game. So, if you prepare yourself, you can make money short selling as Jessie Livermore did a century ago.
Break of Lifetime Low Support Levels:
Whenever you see this type of setups, you should go for an aggressive short selling. Your SL should be @2 times the ATR (Average True Range) that is placed at the high of breakout day. What is ATR? It’s nothing but a volatility indicator that shows how much a stock or its future on an average moves during a given time frame.
Please refer to Chart Example: Coal India
Bear Setup#3. Short at Break of Trend Line: Here I want you to refer to the previous a-b-c pattern. If Nifty50 (Major Indian Index) fails to cross 200 DMA and subsequently breaks the trend line say @ 10650 as I have shown in the chart, short-sell Nifty Future (assuming future price coincides with the spot price) and hold until 9900 before it touches 50 DMA. Your Stop Loss should be at the recent high of 10850
And if the Index goes lower as you predicted, you can make a whopping profit of around (10650-9900) 750 points x 75=56250 INR (Nifty Future lot size-75)
Profit 750 point; SL-200 points and Risk-Reward Ratio-Slightly less than 1:4
If you see the Options Chart of Nifty, you will find that the 2nd highest OI as on 12th July-2020 on the Call Side is standing at strike price 10800 (2,326,350) and the highest OI is seen at the strike price of 11000 (2,591,175).
Those strike prices are regarded as the strongest resistance areas. Also on the Put Side, the highest Open Interest is standing at the strike price of 10,000(2,282,025) which signifies as the strong support area. So you can expect a minimal fall of the index up-to 10000 levels. See the options chart taken from https://nseindia.com
Pharma Index in India (comprising pharmaceutical stocks) does not fulfill the 7 steps process. So, shorting pharma stocks is not advisable for being a very risky trade.
It is an integral part of the bear market trading strategy. Jack Schwager, one the greatest contributor in the field of risk management had put forward in his book “The Wisdom of 30 Successful Traders” Some of them are-
*Bet no more than 2% of the capital in any single trade
*Use Stops, it commits to getting out of the wrong trade
*Hold your winners and cut your losses
* Dare to hold your short position and take calculative risk
*Short selling requires Intense Mental Involvement. You have to do the hard work.
*A good trader can’t be RIGID (you have to be flexible)
*Do not trade IMPULSIVELY or on NEWS
*Never Average a Loss (Average doers are losers)
*Majority of traders out there are habituated to trade the long side in the bull market. This is because our internal subconscious mind is feed by TV, media news that is bullish.
Rules of Short Selling for How You Short a Stock:
*Sell on Good News: Always sell on the good news in the bear market, especially at the strong resistance level or RSI overbought zone. When Indian PM, Modi announced 20 Lac bailout package, next day Nifty opened gap-up and then following several days it retraced a lot as Nifty was trading in the bear market.
*Never Play Macho Man with the market: Never think that you know everything, or you’re a smart trader, or your market analysis is foolproof. Mind that market is supreme.
Limitations of Short Selling Stocks
If you can make money shorting a stock, why is there so much concern among traders? As I mentioned earlier, shorting involves inherent risks. Let’s look at the four most inherent risks and find out how to overcome them.
#1. Unlike regular trading, shorting a stock carries endless risk. To be precise, all trades carry risks. With long positions, the biggest amount you can lose is the amount you paid for. But here in case of short selling, your risk is infinite. That means you could lose a lot more money than you have.
# 2 Normal stock trading on the long side comes with the possibility of infinite returns and limited risk. If you paid $ 5 for a stock, the maximum you can lose is $ 5 when the price drops to 0. But in short selling, the reverse is true.
# 3 Not all shares can be shorted
For traditional stock investment, you literally will be able to buy any stock. But in short selling, the shares available for loans are held in margin accounts. Shares held in the cash-only accounts are not available for loans and therefore are not available to short sellers.
# 4 Liquidity Check: The liquidity of your shorted stock can be lower. This means when you want to hedge your position by shorting, you may not be able to find stocks to buy when you want at the price you want.
You may indeed come across a situation where you can’t find shares to buyback due to low volume. So always try to avoid all low volume or illiquid shares. With high volume or liquid stocks, you will be able to do shorting more easily.
Short Selling in India:
The shorting of a stock India in the spot market has a restriction. It must strictly be done intraday. This means you can short a stock at any time during the day, but you will have to cover your short (square-off) at the end of the day before the market closes. You can’t carry forward the short position for the next days.
This is because when you short a stock, the stock exchange will be alerted that a particular stock has been sold. The exchange does not differentiate between a regular sale of shares that you hold and a short sale. The exchange compels you to take delivery of them. For this, you must have a cash balance ready in your DEMAT account the next day.
At the end of the day, the exchange will keep these shares ready for delivery. And if you fail to take delivery, this will be treated as a breach of obligation and attract a considerable penalty (as high as 20%). This is also known as “Short Delivery”. In this situation, the exchange would address the problem and resolve it on the auction market.
Is This a Dream Year for Short Seller?
The recent stock market crash today has caused a lot of grief to so many traders. All our stocks of “multi-baggers” were transformed into multi-beggar and left us in a state of extreme poverty. Many weak stocks do not go anywhere or going sideways and it is easier to make a lot of money by short selling. This is because we are now entered into a bear market phase.
This may be a short-term or may extend to long due to present COVID situation. If you truly follow my ‘Heed Technique’ the seven steps process and any of the 3-step bear setups, you can make lots of money going short a stock or derivatives of weak sectors like aviation, hospitality industries, auto, and so on.
How to Short a More Profitable Stock?
Short selling can be highly profitable when you make the right call. But it carries greater risks than those experienced by common equity investors. When you buy a stock, the most you can lose is what you pay for. Here you’ll lose the undefined amount of money if you make mistakes. You need to study both fundamental as well as technical aspects and risk management of your target stocks.
Is it Illegal and Ethical to Short Sale Shares?
Uncovered shorting is an illegal practice. Traders usually borrow stock before selling it short. Uncovered shorting is the shorting without borrowing the shares. Short selling remains legal and ethical in most of the stock markets. When markets go bad, governments and regulators sometimes impose restrictions to help stop the decline
What Happens When Short Selling is Prohibited?
Short selling is a bet that the price of a stock will fall over time. At the same time, the exchange could impose a ban on any stock which ultimately reduced the liquidity of that stock. The spreads, as well as the volatility of these shares, increased dramatically during the ban.
Difference Between Selling and Short Selling?
Selling refers to selling something you own. Shorting drives sell something you don’t currently own, such as when you sell a stock. You need to borrow stocks from your broker for shorting and after close your position you will have to return them to your broker. This is how short a stock work.
What is Buying Long and Selling Short?
A long trade starts with buying with the expectation of selling at a higher price in the future and making a profit. But a short trade is started by selling, before buying, to buy back those shares at a lower price and make a profit.
What if you Short a Stock and it Goes to Zero?
By shorting a stock, you are selling something you do not own, and to do so you must borrow the asset. If stock reaches zero, it becomes a gold mine for a short seller. This is indeed an exceptional case.
Why Experts Believe Shorting is Bad and You Should Never Short Stocks?
Shorting a stock is much riskier than buying stock, or taking a long position. If the share price rises sharply after taking a short position, you can quickly hedge your position by repurchasing the shares and returning them to your broker from whom you borrowed them. If you are lucky, you may not lose much. However, critics of short-selling argue that it creates undesirable and excessive instability in the stock markets. But you’re not responsible for that.
Short Sale in the Futures Market
The shorting of a share in the futures and option (F&O) segment has no restrictions. This is one of the main reasons why futures trading is so popular. “Future” is a derivative instrument that simply moves with its respective underlying.
So when the underlying security is going down, it’s future would do so. This means that if you are bearish on a stock, you can start a short position on your futures and hold the position overnight. Like depositing a margin for your long position, the short position would also require a margin deposit.
One of my favorite techniques is when I see a shorting opportunity in the F&O segment, I usually short or write a call option. Just by exploring an Option Chain or strong Resistance Level and The Heed Technique, I do write a Call Option having a profitability trade. If the underlying stock does not move for a while, I take profit due to loss of premium value. This loss of premium is term Time Decay or Theta effect.
You don’t have to be afraid of a short sale. You should be realistic, instead of optimistic. A little fear is good because it keeps you conservative, but you don’t want to feel overwhelmed by anxiety. Gradually, you will gain a broader understanding of how short selling works and whether short selling is a good fit for you.
*Follow Seven Steps Process to identify short selling opportunities.
*Wait patiently and trade any of the Three Bear Market Setups
*Do your Risk Management
*Never play Macho Man in the market-the most important rule
The bear market is very powerful. It puts you in a fast-track process where you can make tons of money in the fastest amount of time. The bear market usually remains around 20%-25% of market trading time. You will face limited competition. So, your chances of making money are huge if do it correctly by following the 7 steps process and 3 steps bear market setups. Whenever you find any of the 3 setups, go for shorts aggressively and earn your living.
If you like my post, please live a comment. Comment, be it positive or negative make me feel good or gives courage for writting useful and value-added content. I am sorry that I am able to add fewer posts these days.