When Investors should Short a Stock

When Investors should Short a Stock

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Shorting a stock is the exact opposite of buying a stock. When you short a stock you are hedging your bets that the stock will go down in price unlike when you buy a stock and believe the price will go up.

Many investors try and short a stock way to early as they believe the stock price is way overvalued. However many times a stock that is overvalued in price may become even more overvalued especially when the stock market is in an extended upward move. The proper time to short a stock is after it has encountered its first major sell off and bounced which sets the stage for a second stronger move to the downside.

Let’s look a specific example form the Spring of 2003. COKE made a strong run from July of 2002 until January of 2003 and gained nearly 75% over a 6 month period.

After peaking in January COKE then sold off but found support near its 38.2% Fibonacci Retracement Level near $59 (point A) and then preceded to rally over the next few weeks on low volume (point B).

COKE then ran into strong resistance as it rallied back to its 61.8% Fibonancci Retracement Level near $65.50 (point C) calculated from the early Janaury 2003 high to the low made during the first week February. This was then followed by an even stronger sell off in which COKE dropped from $65 to $47 over the next three weeks (points C to D).

Thus the best time to short a stock is to wait for it to bounce after it makes its initial sell off and then try and catch the second stronger move downward. When looking for stocks to short make sure they are exhibiting these three characteristics.

1. The stock has already undergone one significant move downward after making a top.
2. The stock then finds support at a certain Fibonacci Retracement Level or Moving Average and rallies on poor volume.
3. The stock then stalls out near its 38.2%, 50% or 61.8% Fibonacci Retracement Level after rallying.

By following these simple rules investors will have a much higher success rate when attempting to short stocks.

Regards,

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