When Investors should Short a Stock
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.
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