Short selling is a great opportunity to reap the benefits of which the market so willingly provides us with but as with everything, there are many risks. While these linger at the back of your mind every time you buy from your broker or adjust your stocks in the market, there are a few rules that serve as guidelines and will assist you in both lowering and preventing the risks at hand.
For instance, if you’re the brace trader that wants to chase lower lows within a momentum strategy, you should really know what you’re doing and have a proven skill set to back you up. If not, you could potentially lose all your profits. This is a dangerous playing field as due to algorithmic front-running, these are filled with the worst prices in the market.
If you want to reap the benefits, follow the rules
- Check the calendar and be sure to avoid bullish seasonality
Do not short sell around the holidays or something called ‘options expiration week’. These could lead to extreme losses as the markets do not follow a steady supply or demand. It allows for a very unstable market of which you should extract yourself immediately. It is also important to avoid these sales when there are low volumes of stocks in the market.
- Be sure to short the weakest market and sector groups and move towards the strongest
Identify the weak market groups that are engaged in downtrends and use countertrends to optimize their presence in the market. In these cases, the stocks are sure to carry lower short-interest than those who are more popular. This reduces the vulnerability factor.
- Make use if short rallies and not sell-offs
Avoid the crowd at all cost and align yourself with the best possible price. Countertrend bounces allow for conditions that will furthermore allow for short selling because you are aware of the price which a will provide you with an upper hand.
- Short conflicted and confused markets
Take advantage of short positions. Especially when bigger indices work against one another. When there is a conflict in the market, there is a set of sell signals that will capture your attention. In this case, sellers have the opportunity make use of tight stops that help keep losses in line and under control whenever alignment points higher.
- Protect against breakdowns that fail
It is important to know your cover price whenever a downtrend returns to a breakdown level and to conclude it whenever such an instance occurs. The stock should never reach a higher price than your breakeven price.
Short selling is best used in the market in bull and bear environments. There is, however, a strict trade entry, as well as a risk management set of rules that are used to overcome a constant threat of short squeezes.