Profitable short selling rules and strategies

Short selling requires a technique that uses the mechanism of the market to transition from a higher price to a lower price. The steep learning curve frightens traders and investors, leading them to avoid learning altogether even in a bear market. However, as long as strict risk management rules are followed and timing is carefully managed, this classic strategy can profit from upward and downward trends.

Of course, it’s easier to profit from short selling in a downtrend, because as Martin Zweig wisely said in his 1986 classic To win on Wall Street, “Trends are your friend.” Despite their advantages, short sellers are still spotted mercilessly in a bear market. They often fall into severe squeezes that can undermine the most carefully set stop losses. This reality check tells us that long-term profit requires more than just investing money in falling securities.

Mastering short selling requires simple entry strategies, perfect timing and defensive trade management. Sellers also need to adopt rules to enhance these strategies while reducing the risk of falling into a short squeeze. These are not foolproof, because it is natural for sellers to suffer shock losses from time to time, but the trick is to minimize these unpleasant parts while looking for positive ways to lower the price to a lower level.

3 Short selling strategy

You can sell short in the liquid market without special restrictions at any time. The current version of the US rising rule will not work until the security has fallen by 10%, so it is rarely a factor in determining short selling. Theoretically, when another customer is short, the broker must have inventory security, but in reality, due to fiercely competitive business practices, naked short selling without corresponding inventory is now a common practice.

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Profitable short selling often follows one of the following three techniques:

Of course, many traders choose to sell short at new highs, believing that the price of securities has risen too much, but this is the source of the disaster, because the duration of the uptrend may be longer than predicted by technical or fundamental analysis. In fact, in a strong uptrend, a large number of weak short sellers provided rocket fuel for higher prices. All that is needed is some upside, and these traders start to cover up, triggering a cascading effect that can add a lot of points in a relatively short time frame.

Example of a short-selling strategy: Ford Motor

Ford Motor (F) demonstrated three profitable short-selling strategies in a single downtrend. The automaker completed the last stop of the bearish double top pattern in September, and then broke below, triggering bearish signals that momentum traders can use to short positions. The decline ended soon, giving way to the failed rebound when the support broke, allowing callback players to join. Prices fell back to weekly lows after 8 days of consolidation, encouraging range short positions. Then the stock crashed, triggering a sequence of repeated entry signals for each strategy.

Despite this perfect example, short selling entries carry significant risks and require perfect timing. It is easy to chase a downtrend, being filled far below the collapse level and falling into a normal retracement. The pullback works well, but modern algorithms usually push the price above the breakout level to squeeze shorts and attract weak buyers before resuming the downtrend. Moreover, as the Ford chart shows, the September rally could have filled the breakout gap above 17 without affecting the bearish technical picture, rather than reversing the August low.

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Short-term sales considerations

The performance of short selling can be improved through the following rules, which reduce risk while focusing attention on the most promising opportunities. Please note that before short-sellers have developed a proven skill set that has been verified by bottom-line profit and loss, they should be cautious to avoid chasing lower lows in momentum strategies. This is an important limitation, because these positions are usually traded at the worst price due to the front end of the algorithm.

1. Short rebound, not sell off

As a short seller, your first job is to always avoid crowds while using their emotional energy to position at the best possible price. A rebound against the trend provides ideal conditions for short selling because you know the price at which other sellers may reload positions. If this group of people is more than the group of people buying broken securities, then the risk is coming, hoping for a new upward trend.

2. Short the weakest sector, not the strongest sector

Let other traders get a case of dizziness, staring at an explosive upward trend, thinking that the safety is too high and they must land. A better plan can identify vulnerable market groups that are already in a downtrend and use a rebound to join in. Surprisingly, these stocks usually have lower short interest compared to typical hot stocks, so they are less susceptible to squeeze.

3. Be optimistic about the calendar and avoid bullish seasonality

Short selling around holidays or during option expiration weeks can lead to painful losses because these markets do not follow the natural relationship of supply and demand. Also avoid short selling in low volume situations and follow the old wisdom of “never short a dull market”.

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4. Temporary chaos and conflict in the market

Take a short position when the major indexes pull each other. When the instruments move upwards and downwards unanimously, these conflicts will produce a bearish divergence and trigger a sell signal. In addition, if the alignment point is higher, the seller can use a relatively strict stop loss to control the loss.

5. Avoid big stocks

Traders like to sell securities with colorful and problematic stories that dominate the financial media and media, thinking that they have discovered a person who makes money instantly, but these problems attract a large number of people. In turn, the security will arouse high short interest, and even in a vicious downward trend, it will significantly increase the possibility of a vertical squeeze.

6. Prevent malfunctions

The new downtrend may be relentlessly tested. When the downtrend returns to the collapse level, understand your insured price and set a physical stop loss as much as possible. There is almost no advantage to stop loss after the position is profitable, so the stop loss should not be higher than your breakeven price.

Bottom line

Short selling works well in bull and bear market environments, but requires strict transaction entry and risk management rules to overcome the continuing threat of short squeeze. In addition, short sellers must conduct ongoing reality checks to confirm that they are not part of the suffering crowd.

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