This Is How I Short Stocks
November 24, 2007
Now that we are in a clearly bearish tape, I want to go over how I prepare for shorts, look for my shorts, what I like to see in my shorts, and which stocks I decide to short. After I do all of this, I want to go over the way I look for my stocks and how I trade. There are going to be things left in and out but if I leave something out I will add to it later in the comments area. Also, in the hopes of not leaving anything out, it is possible that there might be some redundant TA items discussed. Unfortunately, you have to suffer through that, to make sure I don’t forget anything.
The first thing I need to make clear is that this is NOT the first time frame that I have been short since the rally from October 2002. I have a feeling some of you think that I was long the entire time and was never ever bearish before this selloff. That couldn’t be further from the truth. When the selling started in 2004, 2005, 2006, March, August, or now I had no clue it was either the start of a bear market or just a normal pullback in a bull market.
For that, I needed my charts and a few sentiment indicators. The charts I am speaking of are all my charts of every individual stock in the stock market and the sentiment indicators I prefer are the investors intelligence bull/bear survey, the put/call ratio, and the VIX. Those three seem to be more reliable than almost anything else at gaging when the market is near a bottom. These indicators allow me to view where we are at in a downtrend, which allows me to be prepared for the vicious oversold rallies that happen yet not lose my short position.
Now that you know the sentiment indicators I use to judge where we are at during a bear, we will move on to how I start shorting and what I start showing, then we will return to these indicators at the end to discuss where I want them to be at when it is time to cover our shorts.
So, lets say I am starting to notice that all of my recent longs are reversing, my current longs are breaking out but rolling right back into their bases, and the market is flashing distribution days constantly. If I start seeing that my red flags immediately start to raise up and causes me to take warning. Now, normally, I never panic at the start of a selloff, once I start to see this happen. I instead step back and see how much volume is on the selling and if there are any stocks that are showing unusual strength that have very pretty basing chart patterns. If I see these stocks in my scans (that I use to find longs) and I see some of my longs hold up, trending higher with green BOP, then I know that the chances the pullback will last long are slim. If that is the case, I definitely do not look for too many shorts. However, if some appear in the scan that are very juicy, I will take them, in the hope that they will selloff so much that any rally will not have a long term affect on it.
But let’s say we have what we have now: constant distribution days in the market, indexes below the 50 and 200 dma, there are no nice stocks in my long scans, I am cutting losses left and right, all my new longs are acting poorly, there are few good longs in the scan and they are only in defensive industries (tobacco, food, beverage, insurance, medical, drug, consumer non-durables), and now my short scans are lighting up full of possible new shorts and also of stocks that have been trashed.
If that happens, then the chances are high we are about ready to enter a bear market. Now, while I can not predict the future, I can say that NONE of my charts look like they EVER did during ANY of the pullbacks from the October 2002 lows to the October 2007 highs. This is why I feel like it is no longer correct to be bullish and instead feel that it is time to make money on the short side. I have felt this way since very early in November and have been on the right side of the trend so far thanks to the simple methodology of “following the trend.”
Now that it is clear to the trend followers who are quick to jump to the other side of the market, it is time to find some shorts. If you look below in the “strategy” section, you will find an entry on how I find my shorts. I have placed my PCF (personal criteria formula) and Easyscan creations in this section and if you have tcnet/tc2007 you can go there and create the same PCF formula I have created and then add it to your Easyscan to create your own scan and see what I see. If you are a Gold subscriber and have access to the forums, I have made it even easier: I post my tcnet file every other week, with all of my updated scans and updated combined IBD list (that is very tedious and time consuming so very few take the time to do this).
Once you have that scan, it is time to start digging. If you have the scan, you will see this holiday shortened trading session this past Friday only gave us one short candidate. This was CMED and CMED is not a good short. Why? Because CMED is not setting up in a historically proven chart pattern that has produced some of the stock markets biggest losers.
The favorites of mine for shorts include: a stock breaking down below the 50 and 200 day moving average, a stock breaking out then reversing back into the base and finally breaking down on heavy volume, a stock rallying back to either the downtrending 50 or 200 dma on low volume, and for former bull market leader (BIDU GOOG AAPL RIMM FSLR FWLT TNH etc..) I look for them moving back towards old highs and failing on heavy volume and negative divergences in their RS/moneystream lines. While some of these may not be clear to you, they are to the subscribers who have access to my shorts. They have seen all 60 plus taken and have seen one form or another of the chart patterns discussed above. If I have time I might post some for example purposes.
Now that you know what I am looking for, let’s pretend that I found a great short. Now what I do is go look at its fundamentals. If I see a clear breakdown there and the stock is very close to a preferred cut loss area (normally the 50 or 200 day moving average), I will not be afraid to go as heavy as 3% each. However, I prefer to take less risk now and can hold many stock without any problem (I am short 57 stocks now [51 in the green]) and manage them all very easily after 12 years of this. For most of you, I suggest 5% in each short, no more no less. That way if one happens to explode 25% to the upside, over night, you will not be ruined and an emotional wreck. So I prefer to keep things small.
In saying that, I do have some exceptions. After reading “How to Make Money Selling Stocks Short” by O’Neil, I learned that the biggest winners in a bull market also make the biggest winners (on the short side) in a bear market. So I have started small short positions in GOOG AAPL BIDU RIMM AAPL (some have already been cut) so I can have them at this level. If they all rally to higher highs, obviously I will cut my loss. But the goal is to slowly pyramid into all of these as it moves down making sure that I nail a huge move on the downside by all the leaders.
The pattern that I would LOVE to see GOOG AAPL BIDU RIMM FSLR FWLT TNH and others to setup in would be POM on 11/21 but with a lot more volume. The max red BOP, failure at the 50 and 200 dma, after a top six months ago, makes it a nice short. The only problem with POM, by the way (if you know what it is on the chart, wtg!!) is that the RS line is showing very bullish divergence. If those ex-bull market leaders top and create this beautiful price/volume/BOP pattern, it would be wise to make sure that the RS line is hitting lower lows ahead of the price. This bearish divergence would be very bullish for shorts.
Now, let’s pretend that all of the leaders setup in that pattern. If that was the case, I would immediately sell down all of my WORST positions with the biggest losses that I had to to free up the cash to go short 10% each of RIMM AAPL BIDU GOOG and others. If, however, the chart doesn’t look like POM’s chart of 11/21 with the price/volume/BOP (RS line needs to be hitting new lows), I probably will not put that much in each. But if you do put that much in each, the potential reward is not only very large but the risk is very small with the 50 and 200 day moving average being so close.
So to wrap it up, go look at the scans that I have created, in this section. Then after the market closes, go through them to find the best patterns. If there are none, you do nothing, obviously. And if you find something you like, you take a 1-3% position (if you are me) or up to 5% if you are you. However, to find the absolute best shorts, I monitor the top bull market leaders priced over $50 a share and watch them as the market tops (this is our current RIMM AAPL GOOG BIDU) I slowly pyramid into them building a large position when they finally (you pray it does but OBVIOUSLY it doesn’t always happen) finish their selloff from the tippy top and create the exact pattern that POM did on 11/21 (once again, you pray they do this). If that happens 10% for me and for you professionals out there you could go up to 20%. Making sure you always have reasonable cut losses. I prefer the 50 and 200 day moving average.
Some final “no-no’s” are to never short a stock that has been down five straight days. Those stocks are way too oversold on the short term and are almost always going to bounce higher if not that day the next. Also never short a stock that seems to be an obvious short that everyone on CNBC and in the NY times are talking about the company’s failure. If everyone is talking bad about the stock, then the majority of the losses have probably already been seen. But I can’t stress how important it is to not short in bulk after the market or your stock has been down five or more days. It is always wiser to short low volume rallies back to resistance or the moving averages than going short that same stock just breaking those levels after a seven straight day swoon.
Aloha and great luck out there on the short side.
The next subject tackled will be the current way I trade on the long side. The post I have up is a quick revision I did for Investors Paradise in 2006. The original draft that was posted that day was written in 2003.
If you have any questions, post them below. I will check back here every few days to see what is going on.
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In your post you say, “And if you find something you like, you take a 1-3% position (if you are me) or up to 5% if you are you.” What do you mean when you say 5%? Do you mean that 5% of my total portfolio? Or 5% of the total amount of stock I would like to short. For example, if I want to short 100 share, I would start with 5 shares and build onto that. Thanks,
5% OF YOUR ACCOUNT VALUE. If you have a $1 million dollar account you should only invest 5% of it, for instance. Therefore, for your stock, you wouldn’t put more than $50,000 in it.
If you started at 5 shares and built to 100, you would be 100 years old by the time you accumulated your position and you would also be broke in commission cost.
How would those who have an account balance of $10,000, $50,000, or $100,000 apply your 5% rule? For example, 5% of $10,000 is $500 and $100,000 is $5,000. It would appear to me that a minimum balance of $100,000 would be required to apply your methods. Could someone with $10,000 apply your methods and if so, how? Thanks.
are you kidding me?
I can not answer this. That statement is PURE CRAP!
You can’t take $1,000 and only put 5% in it? You can’t? Have you ever heard of:
interactive brokers
tradestation
mb trading
zecco
Any account balance works. Start small for God’s sake.
And troy….you are asking a lot of NEWBIE questions that serious traders would not be asking.
Any amount works. You DONT need $100k or more. If you are looking to get rich off of $500…then DUH!!!!! This won’t work.
But dude, this is not the time to get rich.
I am stunned sometimes by your questions and statments. You need to get your but over to the book section and read ALL of those books before asking me another newbie question.
I am super busy and can not answer these NEWBIE question/statements all day long. You are taking away my time from those who are SERIOUSLY COMMITTED TRADERS.
To think that you MUST have $100k to trade like this is ignorance. Everyone KNOWS that commissions are $1 a share. If you are using ETURD or scottrade or AMTD to trade….that is your problem Not mine. If you pay more than $5 a trade, YOU ARE RIGHT WITH YOUR STATEMENT. YOU will go broke. But if you trade like that…why are you here.? This site is for those who are already on their ways to doing this professionally. This is NOT a good site for fresh out of the womb newbies. You need to know basic investing 101 stuff.
Better start reading some of those books I posted or else you are NOT going to last in this market environment. You are simply too young and if you are looking to get rich….LOL…you are four to five years too late.
Aloha and great luck….you will need it if you are looking to get rich RIGHT NOW, IN THIS MARKET ENVIRO, WITH THAT “YOU CAN’T DO THIS OR THAT” ATTITUDE.
I bring tough love. If you don’t want a HUGE dose of it…read the books I posted on the book section NOW!
Oh yeah, one more thing, that I am sure I have mentioned a thousand times before: If you have not learned how to consistently make money going long….why in the hell are you going short???? YOU NEED TO READ BOOKS AND GO 100% CASH UNTIL YOU LEARN TO MAKE MONEY IN BULL MARKETS FIRST.
Hey Joshua,
You mention above that you had posted PCF and Easyscan parameters. Are those still around, or was this a premium subscriber feature that will stay that way?
Thanks.
Josh, I just wanted to say I enjoy your daily writings–they keep me on the straight and narrow path–i.e., the IBD/CANSLIM path. I also enjoy with evil glee your rants against the fools who have been making comments haha! Passion is something you don’t lack I guess, haha. Since you like Stan Weinstein do you also like Brian Shannon whose new book incorporate Weinstein’s 4 stages of a stock’s life cycle? Thanks.