Since we trade both sides of the market, it's tough for us to accept the fact that almost everyone views falling stock prices as some sort of unavoidable disaster. Most investors aren't aware that much of the "losses" in the financial headlines are ending up as profits in the pockets of informed traders.
There are number of ways to make money in a volatile market. Two of the most effect tactics are (1) Short Selling and (2) buying Counter-Trend bounces. We want to examine both of these methods in detail, so let's start with a basic overview of Short Selling.
Short-Selling provides a relatively simple way to trade profitably in stormy market conditions. In case you didn't know, short selling - also called shorting - is an investment technique that allows us to profit from stock that is dropping in price. Although shorting is actually an elementary process, it is not often used by the average investor. This is because of the bullish "one-way-only" prejudice most of us have about markets and investing.
A New Market Perspective
Shorting is somewhat counter-intuitive. For example, typical investors look for opportunities to profit in the market by buying stock at a price and then selling it at a higher price later on. This is the usual view most people have of the markets and stock investing. If you believe a stock price will go up, you buy shares of the stock and then wait a period of time to see if you are right.
If you are right, the price of the stock will go up and you are rewarded by having the value of your investment increase. However you lose money if the stock price goes down. Skilled investors sell their shares before they drop too much, because in planning their trades they carefully determine the amount they are willing to put at risk prior to the purchase. (NOTE: You'll find our powerful Risk Control Calculator (LINK) to be a valuable took in managing risk.)
Investors usually sell shares of a stock for one reason - because they think the price is going to drop. Well, what can you do if you think the price of a stock is going down, but you don't own shares to sell?
You borrow them.
Borrowing shares of stock to sell when you think the price is headed lower is called "shorting." Shorting is making a bet about the future price of a stock by selling shares that you borrow rather than selling shares you actually own. When you sell a stock you that you borrowed, you have an obligation to return it to the owner. In a sense you "own" an obligation to return the shares, rather than owning the actual shares.
Shorting Isn't Hard
Once you get used to the concept, "going short" is almost as easy as "going long." We say "almost as easy" because there are a few things to consider when shorting stocks. The first requirement for shorting is that you have a margin account, but since most brokerage accounts are margin accounts, you're more than likely ready to go. However, if you find that you don't have one, tell your broker you want to be able to short stocks and they will provide the necessary forms for getting margin.
Next, your brokerage must have the stock on hand for you to borrow.
Literally thousands of stocks are available to short, so this is usually not a problem. Check with your broker to be sure. If you have an online account this is a simple matter. All you have to do is select the "sell short" option on your order entry window and place the order. If the stock is not available to short, you will quickly receive a message to that effect.
Although the actual process that your broker uses to get the stock is somewhat complex, making the short sale and buying shares to cover the short is as easy as placing any other order to buy or sell. With most online accounts you follow the exact same procedure that you use to sell a stock you own, except instead of selecting "Sell" you select "Sell Short."
When you short a stock, you expect the price to go down. If you are right, you are able to go to the market and purchase shares at a price that is less than the price at which you borrowed them. That's how you make a profit.
Example ... If you short a stock at 50 and two weeks later you are able to buy the shares (or "cover" your short) for 40, then you make 10 points per share less broker commissions. If you are wrong and the price of the stock goes up to say 60, then you cover your short position at that price. Your loss consists of broker fees, plus the difference between the price at which you borrowed the shares and the price you had to pay to purchase shares as a replacement.
Realize that it's more important to know that you can short stocks than it is to know how shorting works. We all use various appliances and machinery every day, but few of us know how they really work.
Bottom Line ... In summary, shorting is a way to make money on a stock you expect to go down in price. In order to "sell short" you first borrow shares of the stock from your broker, sell them, and then wait until the price falls. You then buy them back at the lower price, return the borrowed shares and keep the difference, minus normal brokerage costs.
Since the markets constantly move both up and down, learning to go short almost doubles your opportunity to make money. However, there's much more to making money in bad markets than just knowing what Short Selling is and how it works.
In any market - whether up or down - knowledge really is the key to success. This requires training in stock selection, risk management, entry timing tactics, and exit techniques. As experienced traders, we designed The RightLine Report to help you quickly get up to speed with the skills you'll need to make money professionally or part-time. This 3-times a week Report presents over 80 stock picks every month. Each one includes specific entry and exit details that can be implemented any time during a trading session - even after the market closes.
Okay, now you have a basic understanding of how Shorting works, so let's take an up-close look at a RightLine Setup you can use for entering Short Sales. It's called "The Bearish U-Turn."
Read what subscribers say about the RightLine Report ...