10 Common Pitfalls Of Selling Short

10 Common Pitfalls Of Selling Short


A pro recently joked the bear market will end when Joe Sixpack quits his job so he can sell short for a living. Of course, it was Joe who led the charge in the bull's final days, and got his head handed to him for the effort. In other words, it will be time to go long in a big way when the public finally gets around to selling short.
Short selling is the hottest game in town these days, for obvious reasons. But it's still not easy to make money selling first, and buying later. In fact, most of us can look at plummeting charts for hours, and still jump in at exactly the wrong time. This is one of the great truths of short selling.

Let's examine 10 common pitfalls of this classic trading strategy. After you review this list, you'll understand why the practice can cause so much pain. Keep in mind the bear environment actually makes short selling more difficult at times, because the market loves to punish the majority.


1. Choppy Sloppy -- This bear market shows tremendous overlap in daily price range for equities and indices. In other words, pick out today's high and low for a particular instrument, and tomorrow's market will probably trade through a portion of that range. Why is this a problem for short sellers? It undermines logical stop placement, and makes good entry prices harder to find.

2. Duck, Duck, Duck, Goose -- Price doesn't go anywhere most of the time, even in a bear market. The real declines tend to occur quickly, and in sudden bursts. This means you need to wait around for a seller's market to tap you on the shoulder, and/or get burned because your timing isn't perfect.

3. Too Many Bozos on This Bus -- Short selling makes a terrible group sport. Many stocks carry high short interest and attract frequent squeezes, regardless of how rotten the chart looks. And you're the most exposed playing the same tech stocks as everyone else.

4. Misguided Missiles -- So you think you're a wizard when it comes to resistance levels? Well, think again, Merlin. Support-resistance is three-dimensional, and price often goes further than you expect, up and down. This means you'll find yourself shorting into bear rallies that keep on going up, and up, and up. Until you give up and cover.

5. Tummy Bumpers -- Short sellers are their own worst enemies, and your stomach is the culprit. It twists and turns when it sees your short-sale tick up, one penny at a time. This particular agony is not the same as watching an investment take a dive. Our sense of gravity helps us rationalize those events a whole lot better.

6. Monkey See, Monkey Die -- It's often too late to sell short by the time you see a selloff gather steam. Those shorting from higher levels are already looking to cover by the time you think it's safe to sell short. They add buying power to the market when they close their positions. That's why you'll sell the bottom, and get crushed on a short squeeze.

7. Fear of Fleckenstein -- Sure it's the end of the world, but how does the chart look? You may hate a company and think it's going to hell, but you're going to lose money if the chart doesn't agree with you. You can't turn a profit by selling stories short. You need a stock to do that.

8. Tom and Jerry -- That cheese sure looks appetizing, but did you notice the spring-loaded mousetrap? The most obvious selling spots routinely trigger the most violent squeezes. This forces us to find the less-traveled path if we're serious about selling the market.

9. The Unbear Market -- This is a bear market, right? You may not be so sure if you look at the weekly charts. Many stocks and futures have gone sideways for the last 9 months, not straight down. This indicates a balance of buying and selling power, rather than a one-sided rout.

10. Calendar Cramps -- Short sale profits depend on the time of the month. Positions entered around option expiration get burned because of all the put/call unwinding. And buying power can surge near month's end, especially during window-dressing season. This can make a falling market float like a butterfly for a week or two.