We just discussed the most traditional
shorting strategy: You initiate a short position when a stock falls from a Stage Three into a Stage Four. Position traders hold until the stock breaks the downtrend, and then exit. Swing traders may trade the entire downtrend, selling short each time the stock rebounds to resistance and continues its fall. Wise traders cover the short and exit the 'position after no more than two to three days down, and no more than one to two points before the next support level.
Now, for adrenaline junkies, and those with a bit more experience under their mouse, let's look at overextended stocks as targets for selling short. This is a swing trading strategy and is a high-risk setup! Only traders who can closely monitor their trades and issue automatic, buy-to-cover stops with their broker should enter these trades. Setup: Look for a stock screaming skyward in Stage Two uptrend soaring high (several points) above its 20-dayMA on a daily chart. (Note: This is not the same as shorting a stock in the middle of a healthy uptrend.) The steeper the angle of the uptrend, the better! For confirmation that the stock is overextended, scan the stock's price pattern for the last six months or more. How high, point-wise, can it rise over its 20-day MA before it falls back to the 20-day MA? (Remember, major moving averages act as a magnet.) Is it at least as overextended J;10W, point-wise, as it has been in the past? The more overextended, the better!
Check out the industry group, or sector, where the stock resides. The best setups take place when the industry/sector is also overextended and ready to correct. Now wait for the fITst sign of weakness. When you see it, get ready to pounce. An ideal setup takes place when yesterday's candlestick developed into a long, wide-range real-body to the upside. Today, the stock gaps down at the open in an exhaustion gap on high volume. Candlestick alternative: Although stock price rose sharply in the uptrend, yesterday's candlestick results in a doji, indicating indecision, and buyers' reluctance to pay higher prices.
To enter, wait for the stock to trade for a few minutes after the market opens, to ensure it won't immediately gain strength and fill the gap. With weakness confirmed, sell short with a limit order. (More details on gap entries follow.) Because you're dealing with a highly volatile stock in this technique, plan to cover this short quickly. Buy to cover when:
- It nears previous support.
- It has tumbled for two to three days max.
- You have a multiple-point profit. There's nothing wrong with closing a position in a single day if you've made big bucks!
Since you're dealing with an explosive situation, you may take profits early, only to find you left mucho money on the table. My advice? Get over it! Leaving money on the table beats getting caught in a short squeeze.
Indicator
- Volume: As previously explained, volume may vary on falling stocks, but in this setup, high volume (panicky selling) squashes the stock faster, giving you a multiple-point profit in a short time period.
- Moving averages: Stock will be trading high above 20-day MA and all other major MAs
- RSI: Oversold
- OBV: Falling
- Bollinger Bands: Stock touching or approaching upper band, but unable to penetrate it
source: a beginner guide to short term
