When you learned it, you’ve learned the principles of how to short.
There are many articles advising people not to short, since theoretically, the loss is unlimited if you short a stock, ETF, commodity, or future.
The worst nightmare is when there is a (manipulated) sudden surge, and you can’t buy back to cover the stocks you borrowed to short. This is called a short-squeeze.
Worst cases often accompany greed and ignorance.
The scenarios that can bankrupt you are like the followings:
- Short a gambling company – small scaled capital, little or no income, low volume in transaction (illiquidity). The stake is especially higher for those with just one product or one story, and the product or the story went sour. E.g., a drug pending for approval but failed at some stage (but not yet game over), or a platform that might have a lot of users but no profitable business plan and is running out of money (but not yet dead).
- Short sell a penny stock, or a stock that has fallen to < 5% from its height (the reverse of 20x growth).
- Bet more than 10% of your stock asset.
- Buy leveraged shorting ETF.
- Arbitrage between voting stocks and none-voting stocks, or other types of arbitration.
- No protection. No stop loss, no channel break-up protection, and no brokerage protection.
Companies that meet scenario 1 and 2 are prone to be manipulated. Sometimes it is a lucky break, sometimes it is of evil nature, and sometimes, simply a programming error from an institution.
A small company with very small market cap can be easily manipulated by sharks.
There have been cases that the price surged 10X even 300x in a short period of time. If you can’t buy back the stocks to cover, then you are doomed. This is the inferno of short squeeze.
Rule number one of proper shorting:
Choose your target wisely.
Choose the ones with steady decline. Better yet, the whole industry is on steady decline. That means, you should know what you are shorting just like what you are holding.
Don’t short just because you think a company is going to die.
Don’t short penny stocks.
Don’t short those already drop 95% from their tops.
You can use Earning Channel’s typical channel or DIY channel to find good candidates to short. The monthly charts or weekly charts of these candidates formed steady down channels. At any point in time, you can find hundreds of them. You can add other conditions, such as EPS, or the growth rate to EPS, etc. to further narrowing down your choice.
Scenario number 3 and 4 are simply greed. Never bet your farms on others’ farms. Thoroughly studied or extremely confident, whatever you may phase it, if you bet more than you can afford, it is greed in essence.
Don’t be greedy.
Don’t try to get rich in one shot.
You (ordinary guy) do not control the game.
Follow the trend.
Action 2: Use position management and diary to regulate your allocation and risk.
Arbitration involved timing, which is not controlled by you. In addition, voting stocks are often controlled by a few people. These people could manipulate the stocks, or they could be bought out as well.
Arbitration is not for ordinary people.
Don’t try to time the market, especially when the price movement does not form a channel.
Don’t try to guess the top or the bottom of the price movement.
Do not time the market.
Do not engage in arbitration if you are not a full time professional.
Scenario 6, no protection. If you haven’t tied yourself with at least two ropes and know exactly how far you are going to fall, never jump off the cliff.
Rule 4: Always protect yourself in any trading, either for building a long position or a short position. Use principles and mechanisms to protect yourself.
Action 4: Use channel trading and stop loss, and other mechanisms offered by Earning Channel to protect yourself.
This rest of the article focus on protection, especially on how to prevent from short-squeezing. Make sure you can buy back when you need to.
Earning channel was designed based on channel trading and followed the advices from Guru’s such as William J. O’Neil. That is when a channel trading signal is triggered, a market order is placed to carry out the transaction.
As depicted in the following figure. A channel has two walls, four trading lines, and two buy/sell or short/cover points. You establish a long position or a short position according to the trading lines and points.
To carry out a short-sell trade you do the following:
- Short-sell at the short-sell-point. A short-sell-point is when the price touched the upper wall and bounced back to the down-channel’s channel sell line.
Action: Place a market order upon reaching short-sell-point.
Action: Place a stop order at channel break-up to buy back
Action: Place a stop order at cost*1.08 to buy back
You always place protections whenever you establish a new position, either long or short.
- Buy back to cover at Buy-cover-point.
Action: Place a market order upon reaching Buy-cover-point
- Prevent short-squeeze, buy to cover at channel break-up
Action: Place a market order upon reaching channel break-up line.
In most cases, place market orders at the channel cover line, break-up line and the stop loss should have given you enough protection from short-squeezing.
For buy-to-cover, it is suggested that always use market order, don’t use limit order.
However, there is no guarantee that an order will be filled with a market order or any kind of order.
So, the most important thing is to prevent shorting targets that could be easily manipulated. Such as, those with low price, low volume, and have stories that could be told or if lucky to come back from.
Now, let’s exercise with an example.
We chose BGC that forms a down-channel in the monthly chart.
If we use the monthly channel to set the trading points.
We’ll short at $17.07, cover at $7.92 with profit, and have a short-squeeze protection at $27.66. All the lines can be adjusted, above price points are the defaults.
To take a closer look, we find that the daily chart of BGC forms a flat channel. So, a safer bet is to place a short-sell when the flat channel breaks down, and moves toward the longer trend of the monthly channel. Then, we’ll short at $17.78, which is a little higher than when we use the monthly