Rules for Shorting

By | January 25, 2013

Many traders think money can always be made on long side but with this ever changing financial market dynamics money can be made in everyone of market irrespective of Long trade or short trade.

When it comes to shorting stock or Index futures , many people are in the dark. It is more challenging to be short, subject to squeezes; the return max out at 100% — versus unlimited upside for longs.

Shorting stock definition:Shorting means selling first the borrow stock and buying later at lower price. The difference between selling and buying at lower price is termed as profits excluding brokerage and slippage.

 

 

Basic Rules for Shorting Stocks which should be followed by traders.

1. Never short a  Momentum stock: Traders love to short stock which is making highs or rising very fast. Never do this as this will be ingrious to your financial health. I still remember how many traders lost money shorting RNRL and RPL . Recently the Huge rise we saw in United Spirits.Unless you are Superman, never step in front of a speeding train

 

2. Never short based on Valuation alone:It is insufficient reason to get short a stock — ITC ,HUL in 2012 and DLF HDIL in 2008 were having very rich and expensive valuation but these stock keep rising. Never fight the liquidity driven stock. History teaches us that cheap stocks can get cheaper, dear stocks can get more expensive

 

3. Never short without  pre-determined loss – Never short a stock without having proper stoploss and targets. Do not be greedy when you get decent profit Book your profit and exit out of market.

 

4. Fundamentals tell you WHY to short something, not WHEN to short it. ALWAYS have some technical confirmation before shorting. Make a short selling wish list, then WAIT for technical confirmation. (We use Money Flow, Short Term Trend lines, Institutional Ownership, Analyst Ratings).

 

 

5. It is tough to be a contrarian: During Bull and Bear cycles, the Crowd IS the market.

You have to figure out two things:
…a) When the crowd is wrong — Doug Kass calls it “Variant Perception”
…b) When the crowd starts to get an inkling they are wrong

At the turns — not the major trends — is where contrarians clean up.

 

 

6. Look for Over-owned, Over-loved stocks: 95% Institutional ownership, All buys or Strong Buys (no sells), and 700% gains over the past few years are reasons to put names on your short selling wish list.  (That is how my partner Kevin Lane found and shorted Enron and Tyco back in the 1990s).

 

 

7. Beware the “Crowded Short“– they tend to become targets of the squeeze!

 

 

8. You can use Options to either juice your short returns, or pre-define your risk capital (options)

 

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One thought on “Rules for Shorting

  1. Anshul

    Thanks. Will keep a note of these. Have been a victim a lot of time 🙁

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