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Short Selling
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10 Common Pitfalls
Of Selling Short
A pro recently joked the bear market will end when Joe Sixpack
quits his job so he can sell short for a living. Of course, it
was Joe who led the charge in the bull's final days, and got his
head handed to him for the effort. In other words, it will be
time to go long in a big way when the public finally gets around
to selling short.
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| Short selling is the hottest game in town these days, for
obvious reasons. But it's still not easy to make money selling
first, and buying later. In fact, most of us can look at
plummeting charts for hours, and still jump in at exactly the
wrong time. This is one of the great truths of short selling.
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| Let's examine 10 common pitfalls of this classic trading
strategy. After you review this list, you'll understand why the
practice can cause so much pain. Keep in mind the bear
environment actually makes short selling more difficult at
times, because the market loves to punish the majority.
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1. Choppy Sloppy -- This bear market shows tremendous overlap in
daily price range for equities and indices. In other words, pick
out today's high and low for a particular instrument, and
tomorrow's market will probably trade through a portion of that
range. Why is this a problem for short sellers? It undermines
logical stop placement, and makes good entry prices harder to
find.
2. Duck, Duck, Duck, Goose -- Price doesn't go anywhere most of
the time, even in a bear market. The real declines tend to occur
quickly, and in sudden bursts. This means you need to wait
around for a seller's market to tap you on the shoulder, and/or
get burned because your timing isn't perfect.
3. Too Many Bozos on This Bus -- Short selling makes a terrible
group sport. Many stocks carry high short interest and attract
frequent squeezes, regardless of how rotten the chart looks. And
you're the most exposed playing the same tech stocks as everyone
else.
4. Misguided Missiles -- So you think you're a wizard when it
comes to resistance levels? Well, think again, Merlin.
Support-resistance is three-dimensional, and price often goes
further than you expect, up and down. This means you'll find
yourself shorting into bear rallies that keep on going up, and
up, and up. Until you give up and cover.
5. Tummy Bumpers -- Short sellers are their own worst enemies,
and your stomach is the culprit. It twists and turns when it
sees your short-sale tick up, one penny at a time. This
particular agony is not the same as watching an investment take
a dive. Our sense of gravity helps us rationalize those events a
whole lot better.
6. Monkey See, Monkey Die -- It's often too late to sell short
by the time you see a selloff gather steam. Those shorting from
higher levels are already looking to cover by the time you think
it's safe to sell short. They add buying power to the market
when they close their positions. That's why you'll sell the
bottom, and get crushed on a short squeeze.
7. Fear of Fleckenstein -- Sure it's the end of the world, but
how does the chart look? You may hate a company and think it's
going to hell, but you're going to lose money if the chart
doesn't agree with you. You can't turn a profit by selling
stories short. You need a stock to do that.
8. Tom and Jerry -- That cheese sure looks appetizing, but did
you notice the spring-loaded mousetrap? The most obvious selling
spots routinely trigger the most violent squeezes. This forces
us to find the less-traveled path if we're serious about selling
the market.
9. The Unbear Market -- This is a bear market, right? You may
not be so sure if you look at the weekly charts. Many stocks and
futures have gone sideways for the last 9 months, not straight
down. This indicates a balance of buying and selling power,
rather than a one-sided rout.
10. Calendar Cramps -- Short sale profits depend on the time of
the month. Positions entered around option expiration get burned
because of all the put/call unwinding. And buying power can
surge near month's end, especially during window-dressing
season. This can make a falling market float like a butterfly
for a week or two.
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