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What about short selling?I'm certain you have heard about the infamous short selling strategy before and you are likely confused about it because most people are... I say infamous because it gets bad press from the investing community on a regular basis and because some people have a lot of difficulty grasping the concept it self , so here we go: Short selling allows you to make money on a falling stock price. When selling short, you sell a stock that you don’t own (you borrow it from your broker) and try to buy it back (covering) for a lower price. For example you sell 100 shares of XYZ short for a price of $10 per share. This will ad $1000 to your account. No, the money does not actually get credited to your account since you are only borrowing from you broker. If you buy those 100 shares back for $9 per share that will mean you have to pay $900 for that transaction, leaving you with a $100 gain. When you are shorting a stock, your potential risk is unlimited since a stock can go up more than 100% but sink not more than 100%. Therefore I would stay away especially from small stocks (they often rise dramatically in price) when shorting! Shorting rules and restrictions Short selling is a little more complicated than regular buying because of specific rules and restrictions:
So why would one want to short sell considering the risk is limitless and the rules make it difficult? Let me answer that question by posing a question: What will you do in a down trending market? Go against the trend? I think we have already addressed this… Sit on your hands and wait for months or years waiting for the next uptrend or bull market? BTW, if you don’t want to short sell and understand the inherent risk of trading against the trend, this IS your only option… The reality is that short selling is what will put you head and shoulders over the rest of the crowd. Remember that conventional wisdom says you should buy on the dips , or hold on to your stocks and wait for them to come back. While this may work for investors when a short term correction occurs in a long term bull market, it doesn’t work in a true bear market, and it certainly doesn’t work for short term traders. A true bear market can last for years. Investors that follow the conventional wisdom in a bear market may lose not only all of their hard earned gains; they may lose a large percentage of their original capital as well! As a trader you’ll have an incredible advantage over others because you’ll be able to make money consistently regardless of whether the market is going up or down! In other words if you want complete freedom over the direction of the market and make returns your friends won’t believe, you need to be able to short sell. One reason why you’ll make indecent returns short selling is that prices tend to fall much faster than they rise, which presents great profit opportunity for traders. If you only attempted to trade the bounces in a down trending market, you would miss out on all these other excellent opportunities. The reason is quite simple: People tend to panic when they think they may lose money, which causes prices to fall much faster than they rise. Remember this telling metaphor: “Bulls go up the stairs but bears come out the window” So why doesn’t everybody short sell? Many reasons for it, the single most important one is lack of knowledge. Not many people know about it… Amongst trader the single most important reason is FEAR. Since there is no inherent limit to the amount of potential losses when shorting stocks, people think the stock price could go up to infinity causing them to lose all of their money, or worst yet, even more than the amount of their original capital! Of course reality is different but overcoming the fear associated with shorting is initially an issue for many traders. The reality is no stock will go to infinity. If you employ good money management and use stop-loss orders to limit risk, the most you can lose is the amount of your predefined risk. About the worst that could happen is that your stock gaps up in the morning because of good news however the same could happen if you go long To summarize, if you are serious about trading then you need to be capable of making money in both up and down trending markets, which means you need to be capable of applying the short selling strategy. ALL good traders SHORT SELL. I would even go as far as to say that short selling is the most significant strategy you have as a trader, VS an investor. An investor worries about the direction because for him to be successful, the market must go up. The only thing you should worry about is that there is a direction. Considering we might be getting closer to the worst crash in history you WANT to be able to short sell because it will absolutely make you filthy rich! Shorting TIPS Generally you should use limit orders rather than market orders when shorting stocks. Using market orders increases the risk of getting shares at unfavorable prices, particularly when prices are changing quickly. If the price is dropping and you place a market order to sell short your order may not execute until the price bottoms and buyers step in to generate the required uptick. As a result, your market order could fill at the worst possible price. However, there are a few instances when you could consider using a market order to ensure your order will be filled, if you use reasonable care and discretion. In the case of indexes, holders and ETF’s, which were discussed earlier, since the prices tend to move more slowly, you could consider using a market order. Once again you should take into account the specific conditions that exist at the time you place your order, such as how volatile and fast the price action is, and then decide the best course of action accordingly. In general you need to use limit orders to also ensure your trade is executed as planned. The risk/reward for a trade is based upon your planned entry and exit price, so using limit orders ensures your orders will fill according to your plan… Remember: “Plan the trade, trade the plan”. Buyers wanted As I mentioned earlier, in order to short sell you need buyers for your shares. There fore, it’s easier to enter a position when shorting into strength. If you wait for a sell-off to begin, it may be hard to sell short due to both the uptick rule, and the lack of buyers. A short trade may require a bit more courage and conviction at times. You may need to enter a trade sooner than you would when selling short, and you will need to trade contrary to everyone else. You will really need a level 2 if you want to be effective shorting stocks. On your level two quote screen, you can watch for indications that buyting is beginning to taper off and selling is beginning to increase. As this occurs, you’ll notice the overall quantity and sizes of sell orders increase while the buy orders decrease. The time and sales display shows trades beginning to shift from the best ask to the best bid, or to a more evenly divided mix between the two. When the timing looks most favorable for a price pull back , but without waiting too long, enter your short position. With a little practice and experience, the timing of your entries and exits will improve. Since you must short into strength, and since no one can pick the exact tops and the exact bottoms every time, it’s more likely that a short trade will go against you a little at first. As always, you should still protect yourself against losses with a stop-loss order. However, taking into consideration the need to short into strength and depending on the circumstances and your risk tolerance , you might want to give the price a little extra room to fluctuate. If using as wider stop exceeds your risk tolerance, you can also consider using a smaller lot size to reduce risk. One way to deal with falling prices is to actually place your limit order a reasonable distance below the current best bid according to the minimum price that you’re willing to accept as an entry for the trade. This will let you get ahead of the rapidly falling price and provides a reasonable range in which the price can temporarily uptick so your order can fill. Of course, the risk/reward for a given trade should remain favorable even after allowing for a somewhat lower entry price. Short squeezes Whenever you are shorting stocks, you should take into consideration the potential risk of getting caught in a short squeeze. A short squeeze can occur when the price of a stock that s heavily shorted, and/or the overall market starts to rise. As the price goes up, people rush to buy to cover their short positions. This additional buying causes the price to climb even higher, which in turns compels more short sellers to cover their positions. Depending on how the market is trending, and the quantity of shorts, a short squeeze can sometimes take on a life of its own, feeding on itself as more and more short sellers run to cover their positions in conjunction with other investors jumping in on a perceived rally. As you might imagine, a short squeeze can result in very rapid price increases. Here once again, you need to place a stop-loss order in case you do get caught in a short squeeze. While we are on the subject of shorts you should always look at how badly a stock is already shorted when you decide to short it, especially if you plan to hold your position overnight. If you do, make sure you know when the dividends are to be paid and also when earnings come out… If you happen to be holding position short when dividends are paid you will have to pay the corresponding dividend and if you hold through earnings and the earning happen to be good, you will get caught in a short squeeze, so do your due diligence! That's it for the short selling strategy! I hope you now have a better grasp on this important concept... Now you're ready to move on to the next section about the LEVEL 2. 
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