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Short Selling

Short selling is one trading tactic that investors and traders can utilise to profit from falling markets. In theory short selling is a process of selling a stock without actually owning the underying shares and buying it back at a lower price at a future date. Traditionally, institutions will borrow stock so as to sell them short, however private investors can achieve the same effect using spread betting or CFDs.

Spread bets also offer the advantage that you can short sell a share or other market to take advantage of falling prices just as easily as buying the stock (going long). This permits you to take a bet on a share or index going down. Executing a short trade is done in very much a similar way as a long spread betting trade and can be done on a live tradable price quote. Please note that selling a stock may be subject to specific rules in some countries.

Note that shorting stocks is always risky because of a rapid bounce or a takeover situation, so you have to be very savvy with it.

So I’m saying we don’t need to day trade all market conditions but just the most profitable ones.

Here’s one simple strategy I use to day trade -:

The last three months gave 134 trades using 60CCI +/-100 line breakout with a price breakout of at least the previous 20 periods plus a break of +/- 0.16% from the 40ema (20 Wilder m/a) on a 1 min chart and exiting 40ema price cross The trading time was limited between 08:00 and 12:00 Mon-Thurs. It gave me:

2828 pips winning points from 83 trades = ave 34 pips win per winning trade.
704 losing points from 51 losing trades = ave 14 pips loss per losing trade.

Win: lose ratio (trades) 4:1
Ave win per all trades = 15.8 pips

That’s one of the three strategies I day trade – very time consuming & lots of discipline and I only took a handful of the trades.

I have looked back through the charts it looks amazingly successful, Next week I would like to paper trade using that strategy if that is ok, but one question I have is what is the signal to exit a short trade?

Take half at ten points profit and the rest at 40ema price crossover. Taking half at ten pts is very important to long term profits because it means if the remaining half gets stopped on a retracement you will still exit the whole trade without a cash loss. That’s so important imo that given the choice between grabbing ten pts on each trade or letting it run, I’d choose to just scalp the the ten pts. The initial stop is the bottom of the signal candle. Once ten pts are banked the remaining position is run to the 40ema.

The chart below shows the first trade (red) fails and hits a 5 pts initial stoploss, so not much damage done.
The second trade (green) wins both the 10 pts plus the remaining position to give a good profit.
The third trade (blue) fails but half the trade grabs 10 pts while the remaining half goes into loss of 5 pts. So, you have won 5pts from a losing trade.
This is quite common.
The forth trade (green) is another clear win.
Clearly a bit of discretion is required with the initial 10 pts. If there were no candles running against you and momentum looks strong I’d be inclined to run the first half of the trade until the first reverse candle.

Shorting Strategy

If a hedge fund has a system for spotting market pricing anomalies then of course there is no reason why these anomalies should not be a mixture of over and underpricing and if an overpricing is identified then of course a short position will have a positive expected return. But if one has no reason to believe the market price is “wrong” then a long position has a positive expected return (vs risk free) and a short position has the mirror image negative expected return.

Short Cover

There is a risk with shorting in that one day you might be forced to buy in on a short position. To my mind If I go short say using CMC Markets they have to borrow the stock to match my trade. At some point that stock has to be returned to the lender. The lender gets a premium and everyone is happy.

If you are long, you buy the stock either outright with cash you have or with money you borrow if it is a CFD or spreadbet. Nobody can force you to sell the stock, because it is in your hands. The only thing that could happen is a margin call if you are on a CFD or a spreadbet, but as long as you can meet the margin call (extra cash) nobody can force you to sell the shares.

If you are short, you need to borrow the stock, you then sell the stock you have borrowed and you hold the cash in your hands. If you go short through a spread bet or CFD it is exactly the same, the only difference is that this process happens in the background. The key difference to a long trade is that in a short trade you have borrowed the stock, whereas in a long trade you have borrowed either nothing (if you bought outright) or money (if you used CFD/spreadbet). The lender of the stock can ask for the stock back at ANY TIME. If that happens, your broker will typically try to borrow the stock elsewhere. If they cannot, you get a buy-in notice, which means you have to buy back the stock in the market so you can return it to the lender. Remember you have sold the stock that you borrowed. The only way to return it is to buy it back at whatever price the market is at. If the market has moved up since you went short, you are shafted.

The only thing that may be true is that spread betting companies may shield you from the risk of getting bought in. Perhaps they do indeed honour a down bet once made, and if they get forced to return the borrowed stock, they may buy back the stock at their own risk. Maybe. But I would be surprised if they took this kind of risk.

UPDATE: I called IG Index and after a long conversation they confirmed that indeed once a short or “down” bet is opened, they will honour that bet even if subsequently the stock becomes unborrowable. This is very interesting because it means that a spreadbetting provider (or at least IG for that matter) will indeed shield you from the risk of a forced buy-in. This means that IG will effectively take the risk of a buy-in, whereas if shorting with a stockbroker or through CFDs, the punter has the risk (as I have learned to my detriment).

This explains a lot. For example, I almost never have issues shorting stocks, even when others say they cannot short through spread betters. I bet that if I ring my stockbroker now, they can short EPO on a CFD for me. The reason why it is possible for me but not for spread betting punters is that there is a big difference in the buy-in risk. My stockbroker will happily short any stock for me, but they may call three days later with a buy-in notice. Spreadbetting providers will only open a down bet for you if they are confident of their ability to borrow the stock as they bear the risk, so their approach will be much more careful.

IG Index normally display the yellow telephone order only icon as soon as they become concerned about borrowing stock (or indeed about a large long exposure) and they only take the trade once they are covered and borrowed the stock. You will also note that their guaranteed stops get very low as a risk management measure as you increase your position.

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