Stock trading. Stock school.
February 6, 2012
Shorting Stocks – Big Picture
Shorting stocks is a higher risk game right now, especially when you consider that the Government and Federal Reserve (private bankers) are trying to prop the stock markets up during this election year. However, they don’t prop all of the stocks up all of the time. So right off the bat, the odds are against you if you are shorting in the near-term.
Additionally, from a historical perspective, the stock market has trended higher for over 200 years, and furthermore the average period of a Bull Market is 3.5 years while the average length of a Bear Market is 1.5 years. Again, on a longer-term basis, the odds are against you if you are shorting.
Furthermore, when you short a stock, because a stock price can go to infinity, you can lose all of your money. But if you short a stock and it falls and you are making money, the amount you make is finite, or limited, because when the stock price goes to $0 that’s it….
Finally, the Government and Securities and Exchange Commission (SEC) can change the rules of the stock market with a stroke of the pen. In 2008, the markets were falling and the SEC ruled against short selling financial institutions and other significant companies….so you can be making money “shorting” and overnight have your butt handed to you because the Powers That Be decided you are un-American and making betting on the misfortunes of others. By the way, Investment Banks were allowed to short all stocks – because they own the rule makers. And have you ever heard of the SEC halting “buying a stock” because it was going up too fast? Nope. Again, the field of buying long and selling short is tilted in favor of buying long. Short sellers beware.
With that said, in times of a down-trending stock or market, it is nice to make money instead of sitting in a losing long position, or in cash. Caveat: these days you can “buy long” an Exchange Traded Fund (ETF) that shorts an industry or market – and thus you don’t ever have to learn shorting techniques. There are advantages and disadvantages to buying short-side ETF’s, but that’s another topic for another day.
The best time to short stocks are when:
1) The overall stock market is overbought, in a trading range, or trending down, and
2) The stock I am shorting – its industry is in a downtrend, and
3) The stock I am shorting has entered a downtrend itself.
What time frame am I talking about for each? It doesn’t matter, just make sure if you are a short-term trader that the short-term trends are down, and if you are longer-term the longer-term trends are down (determining trends is another topic).
I look for certain chart patterns (and these apply on any timeframe). I want to see the stock first move in a “false” direction, breaking out to the upside, then reverse and hit a new low for the day, then when it tries to bounce back and rally towards that daily high, I enter the short position as it approaches that high and place a stop from .01 to .20 cents above that day’s high price.
The first example if AAPL.
Example 2: $NFLX
Exiting a short position:
I tend to lock in some profit after I have reached my price target, then I trail a protective buy stop as it falls to keep me from losing all of my profit but allowing me to ride the winner.
Selecting the Right Stops
There are 3 requirements for making money in stock trading. The first is having a proven, successful method for picking stocks. The second is having a sound risk management plan, which involves determining Reward versus Risk and where to place protective stops, and the third is controlling emotions. By far, the computers excel over humans at controlling emotions.
But I have found that there are a couple of things the computers have difficulty doing: 1) Humans can select profitable chart patterns better than computers, at least until Artificial Intelligence improves further, and 2) Computers have more difficulty moving stock prices when the stocks have large average daily volumes.
Selecting profitable chart patterns, determining reward versus risk (risk management), and controlling emotions are topics for another day. Let’s talk about placing initial protective stops in the right location.
As I was trading in January and February 2011, I noticed an unusually large number of my trades were losses. (See January and February 2011 at http://stocklooker.com/performance/.) As any trader must do, I started analyzing why I was always being stopped out of my trades – even though my method of placing stops had not changed in years. I noticed the stocks would hit my entry points, which were almost always above or below resistance and support areas, and then almost immediately the stock would move against me and take out my stops. Again, when you trade a while you notice these things are not normal. (I later realized it was computers manipulating my stocks on practically no volume. See this article)
Returns on 50k account:
Jan 2011: ($1043)
Feb 2011 ($2698)
changed stock selection and stop placement, but stop placement was the real key
Mar 2011 + $6,445
Only had 1 more losing month the entire year
3 Changes:
1) I started trading stocks that were not market darlings, like Apple (AAPL), Microsoft (MSFT), Priceline (PCLN), Google (GOOG). These darling stocks are heavily manipulated by computers and the Federal Reserve because you can move the Index by manipulating just one of these stocks.
2) I gave the stocks “more room” between my entry price and the stop price, which also means I had to decrease position sizes in order to control my losses at a certain amount.
3) If I was trading a stock intra-day, I would still choose a stock with at least a 3-1 reward-risk ratio (discussed in another article), but I also increased my hold times from hourly to daily. My hold times went from an average of 1 day to 15 days, approximately.
Here’s examples of stop placement, that will work whether you invest for the long term, or trade intra-day.
Buying a stock:
I look for a strong downward move in price accompanied with volume (green circle). I also want the relative strength indicator (RSI) to be higher in value when the stock tests its previous low (see low 1 versus low 2 red circles). I determine the low price of that lowest price bar, in this case $37.58, and I wait for my stock to retrace that strong move down. The stock hits my buy point at $37.93 on a “breakout” and I immediately place my sell stop at $37.56, just below the lowest low of $37.58.
I then place a trailing stop as the stock moves higher. In this particular case, once USO moved out of the secondary base pattern at $38.37, I moved my stop up from $37.56 to $38.19 and locked in a gain.
State of the Markets – 2012
The stock market has always been “rigged,” and there have always been “crooks,” but we have entered a new era the past 5 years, and if you watch the markets for any length of time during the day, you know what I am talking about.
In the “old days,” a “rigged market with crooks” meant the Wall Street Investment Banks traded inside information, information not available to the public, and used CNBC and other talking heads to move stocks in their favor for profit. The “insiders” also would front-run (example Article here and here) the public’s stock trades with their own trades, and occasionally would get caught. When caught, they would receive a hand slap, pay a pittance portion of their profits made illegally, not have to admit wrongdoing, and keep on trading. It’s been going on for a long time (1814 scam, several here).
In the current cheating era, there is legalized cheating, that which is approved by the Federal Government behind closed doors, and illegal cheating – that which is not publicly approved by the Government. Additionally, as opposed to the “good ‘ole days,” the way in which the scams are carried out are far more complex due to the technology explosion in the past 10 years and the invention of automated/digitized trading. By technology explosion, I primarily mean computer speeds, which have enabled the creation of high frequency trading computers. Investment banks are now able, and in my opinion, “allowed” to see the public’s open trades and execute their own trades ahead of the public while the Securities and Exchange Commission looks away (see this). Additionally, “quote stuffing” (similar to Turkey Stuffing, and we are the Turkeys) makes it almost impossible to tell if a stock price is real or fake (article).
In the old days, you could trade stocks using either fundamental or technical analysis. Investors typically used fundamental analysis, the analysis of a company’s financial data, to determine which companies to “invest in” for the long haul. Traders typically used technical analysis to enter and exit a stock based on chart patterns, with the charts patterns themselves generated by “market psychology.” When a stock price moved sideways, it would mean that the intensity of buyers equaled the intensity of sellers. If the stock price moved upwards and out of a “base,” (horizontal pattern), it meant the buyers were willing to pay more for a stock, and also that short sellers (people who sell a stock at one price and hoping to make a profit when the stock falls) were cutting their losses.
These days, neither fundamental nor technical analysis can be used with any high degree of certainty. Two primary reasons are:
1) The stock market is now completely controlled by the Federal Reserve (which is comprised of the Too Big To Fail Investment Banks), so why waste time wondering if Apple (AAPL) is going higher – buy that sucker!!! And
2) 70% of the stock market volume is generated by computerized trading, which doesn’t know bounds. The computers simply see where the open stock trades are, then goes and gets them.
Fundamental analysis went out the door with the Internet Boom of the late 1990’s – when Yahoos of the world traded at 700x earnings. “Value” Funds (they look for value based on earnings) were getting absolutely killed by Growth Funds, so they changed their definition of “value” by changing how a company was valued. P/E’s meant nothing as long as earnings and sales growth were strong, so that small change allowed Value Funds to chase the high flying internet stocks and compete with growth funds – for customers. Of course that didn’t turn out well. And how is one supposed to “value” a company when the Government changes the accounting rules when things go bad for a company? Moving target.
Technical Analysis, which uses stock chart or pricing patterns, has been the most dependable over the years, however, it too has become much more irrelevant since 2008 when the US Government and Private Banking Cartel (a.k.a Federal Reserve) started propping up the stock markets with newly printed money (Quantitative Easing 1 through Infinity) – an act started by Greenspan and his famous “Plunge Protection Team” and carried forward by Bernanke, who I warmly refer to as Bernokio. Computers don’t have emotions, which previously were required to create a genuine chart pattern with price support and resistance levels. Instead, the trading computers now run algorithms which manipulate a stock above and below these price support and resistance areas, which negates the purpose of a chart and trend. Of course it also is difficult to trade against the Government’s “approved” computers which can actually see the prices of where all of the open trades are sitting now, doesn’t it?
The good news is – there is still hope.
