Volatility has returned in 2018, which is traditionally a better sign for short-term traders than for long-term investors. Increased volatility usually means more opportunities to play both sides of the market, long and short. But shorting a stock is not quite as simply saying “I think this stock will go down.”
It’s far easier to lose your shirt shorting than it is by going long. Here are a few common mistakes to avoid when hopping on the short side of a trade.
It is extremely important to set a clear exit point of every short trade because the theoretical risk involved in a short bet is unlimited. Stocks can only go down 100 percent, but there’s no limit to how far they can go up. So while it’s always good to set a clear exit point for every trade, regardless of whether it’s a long or short, it’s probably more critical when betting on the downside.
This means either having a sell-stop order in place or at the very least having a specific number in mind for when to give up on the trade.
If a stock seems like an obvious short selling opportunity to you, there’s a good chance you aren’t alone. Stocks that are popular shorts will have a high short interest or high short percent of float. These stocks are prone to “short squeezes,” or sudden bursts of upward pressure that can trigger automatic covering by short sellers (at least, the ones with stops in place or who don’t have enough cash or margin in their account to cover the losses).
While short squeezes can happen seemingly at random, they tend to happen to stocks with smaller floats.
In addition to the standard trading fees associated with all transactions, short sellers must pay a stock loan fee in return for borrowing the shares they then sell short. The more difficult a stock is to borrow, the higher the fee. Some of the most popular stocks to short also come at the highest cost because nearly all of the shares available to borrow are immediately snatched up by short sellers. If ignored, these fees can take a huge bite out of profits.
Shorting is all about timing. Sure, you need to have been right in the first place, but if it takes 3 years for your short thesis to play out and you can’t take 3 years worth of pain, then you’re out of luck.
Don’t try to be a hero and call a top. Many a short seller have been burned by thinking a stock is overvalued and just about to go down.
Unless you can afford to be patient and take the pain, wait for a stock to give you a reason to short it. “Being overvalued” is not a reason.
This is one of Jim Cramer’s rules for shorting. Buyouts, or even just buyout rumors, are the arch nemeses of a short seller. They are unpredictable and can send a stock soaring higher during off hours when you literally can’t make a trade.
So before taking a short position in a stock, at least consider the likelihood the stock could be a takeover target. Are there persistent rumors? Maybe look elsewhere.
Watch our Video, How to Locate Stock for Short Selling on Lightspeed Trader
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