When I find a stock that I want to short, how do I trade it? My opinion about a short is not sufficient for a trade, the chart has to agree with me or I have to wait until it does.  Here are the charts of four profitable short plays I had this year. While I did not catch the full moves I caught the meatiest parts for very nice profits. My system is to find a falling leader in a market correction like Apple. Or I will short the stock of a company that has made major missteps and caused a downtrend based on fundamentals. My initial short entry is when it closes below the 5 day exponential moving average. I will hold the short position until one of three things happen.

I exit the short when:

  1. It closes above the 5 day ema. (Moving average stop.)
  2. It closes at the high of the day. (I will get out in the last thirty minutes of the day it is closing at the high of that day.) (Candlestick stop)
  3. It plunges and then reverses doubling its normal daily trading range closing near its highs. (Volatility stop)

I only risk 1% of my capital on any one trade.

I use in the money stock options the majority of the time so it has built in risk management so I do not need to set intra day stops. I position size to control risk with the options.

If I am stopped out of a short I will re-enter when the stock drops back below the 5 day ema. The key to this system as for all trend trading methods is you have to have small losses and huge wins for it to be a winning system. If you have an ideal entry after the stock plunges below a major support like the 50 or 200 day simple moving average that can also improve this systems performance by catching the monster trend.

World's Easiest System for Trading the Short Side
Chart courtesy of TrendSpider.com

By Steve Burns

After a lifelong fascination with financial markets, Steve began investing in 1993 and trading his accounts in 1995. It was love at first trade. After more than 30 successful years in the markets, Steve now dedicates his time to helping traders improve their psychology and profitability. New Trader U offers an extensive blog resource with more than 4,000 original articles, online courses, and best-selling books covering various topics.