Date: 1/28/2022
Author: Chris Hood
Be sure to check out new episodes of my video podcast each week, where my ace pupil Brian Jones and I talk the ins and outs of options trading- and give you insights and strategy that you can immediately put to work for you in the markets.
There’s a certain mystique about going short.
Maybe it’s because of hit movies like The Big Short.
In the film, Scion Capital hedge fund Michael Burry discovers what he believes is a crack in the US housing market from too much subprime lending.
His analysis was correct, and he shorted securities backed by these ‘faulty’ mortgages with nearly a billion dollars.
Though Burry was right, he was early, and his fund to a lot of heat as the market continued to stay afloat.
However, he stuck to his guns, and when the bubble finally burst, his trade paid off, netting his fund a near 500% gain. Unfortunately, many other investors lost vast sums of money during the financial crisis.
A lone trader bucking the system because he’s confident he’s right.
While it’s a gripping tale, it sets unrealistic expectations for retail options traders looking to profit from drops in equity prices.
I like making money playing short, but it has to be done carefully. Always remember that the stock market is designed to go up over time.
Short trades go against this trend, like running with a parachute attached to your back. It’s a hard run, and a sudden gust of wind in the form of a rebound or reversal could make you lose big.
Here are a few key points to keep you safe when you decide to play the downside.
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First, play the charts rather than the fundamentals.
Burry’s idea, while correct, was based on his idea that the market would fall.
It did, of course, and he made money. But many hedge funds lost big on their long positions. What’s important here is to remember that trading an idea is a low-probability endeavor.
Burry’s wild success on this idea was atypical.
At the time of his trade, he was more likely to lose than win.
Second, trading short is most effective on reduced time frames and when stocks are trading below critical levels of support.
Going short simply because stocks seem overvalued or oversold usually leads to significant losses. Bearish trades on tickers that are in a solid uptrend above the 21 EMA on the weekly chart and have bullish signals on the daily is simply the wrong move.
We always want to focus on probabilities rather than possibilities.
Is it possible for markets to take a huge dive seemingly out of nowhere?
Sure, it will do whatever it’s going to do. But the likelihood of these drops is low, and intelligent retail traders should look for bearish signals before placing downside bets.
A bull market, even one underlying weakness, can keep rising longer than you can afford to be in the trade.
I do recommend that you learn how to trade to the downside.
As we’ve seen over the past couple of weeks, major institutional sell-offs can happen. As a result, you can make money regardless of market direction if you understand short trading. However, shorting is much more stressful because sudden bounces can wipe you out.
I discuss short trade opportunities in much more detail on the latest Hood Talk YouTube episode, but I’ll leave you with a few words of advice.
– Keep your position size small
– Short only if you fully understand support and resistance levels
– Never fight the market trend
– Look for low-cost ways to short such as buying calls on inverse ETFs (SPXS, QID, or PSQ)
– Keep your stop loss to the upside tight in case of reversals
As always, trade smart and trade safe.
Cheers,
Chris Hood
P.S. I’d like to extend a personal invitation for you to join our group of AlphaHunters and learn how to navigate the market profitably. If our recent win of 60% on AAPL in only 6 days sounds good to you then click here to learn more.
