Guide to Shorting Stocks

When the bearish sentiment arises, it is always tempting to short stocks to take advantage of the market downturn. What is shorting then? Shorting stocks is simply borrowing stocks from your broker and selling them in view that the price will go down. You will then buy back the stocks at a lower price at a later time, taking the difference as your profit.

But be careful, shorting stocks can be very tricky and more difficult than going long. While the maximum potential loss for going long is 100% of your capital, the potential loss for shorting is greater than that as stock price may turn its way back up and sky is the limit. On the other side, shorting will give you a potential return of maximum 100% while going long will give you greater return than that. So from the risk-reward point of view, shorting is actually less attractive. Further, stock prices tend to go up in the longer term.

If you want to benefit from a declining market, there are a few conditions to consider when you decide to short stocks.

1. Look at the market trend in general. Do not short stocks when the market is in an uptrend, regardless of the bearish sentiment of a particular stock. It is better to be sided with the market than go against it. Only short stocks when the market is in a confirmed bearish trend.

2. Look for companies with weak fundamentals. This includes those companies experiencing declining sales, profits, or margins, companies currently having legal battle, losing its market share, or anything that contributes to its sluggish future outlook.

3. From technical perspective, look for companies failing its attempt to break certain resistance level. This could be double top, triple top, lower trend lines, 50-day moving average, 200-day moving average, etc. A failed attempt to break this resistance indicates a large amount of energy that will push the stock lower.

4. Be precise on your entry point. Do not enter when the stock price is already down for a few days in a row. Do not enter when the stock gaps down after its prolonged downtrend. This could be an area where bargain hunters come in and try to pick up the stock, which is usually followed by a rebound in the stock price. Wait for the stock to rebound and show its strength, if it fails and turns back down, then it becomes a safer entry point.

The author is the founder of http://stock-trading-for-beginners.com, a website dedicated to anyone who has passion in stock trading and would like to learn more and master the trading skills. Check out many other articles at the above website.