The Little Black Book of Stock Market Secrets by Matthew R. Kratter

Author:Matthew R. Kratter [Kratter, Matthew R.]
Language: eng
Format: epub
Publisher: Trader University
Published: 2017-03-02T20:00:00+00:00

You can also access the chart at the following link:

www.tradingview.com/x/NMm9yLS5/

Now most people would find it quite difficult to short a stock that had already fallen 36%. But we know that the time to short a momentum stock is when its momentum has sharply reversed, and not a moment before.

Then on January 2, 2008, the 50-day moving average closed below the 200-day moving average and the stock closed at 37.90. If you had gone short the following day at the market open at 38.00 and set your stop at 10%, you would have been able to ride the stock all the way down from 38.00 to 3.02 (which is where the stock was trading when the 50-day moving average finally crossed back above the 200-day moving average). You made 92% on this trade, and risked only 10%. That is about as good as shorting can get.

There is one more thing that you should know about shorting momentum stocks. When you borrow shares of a stock from your broker that you wish to short, you will need to pay a fee that is based on how long you borrow the shares for. When many people are trying to short a certain stock, that stock will be on the “hard-to-borrow list”—meaning that it can be expensive to borrow the shares from a broker.

Sometimes these fees can be as high as 100% annualized. This means that if the stock that you have shorted goes to zero in one year, you make 100%, but need to pay your broker 100% (because the stock was hard-to-borrow and you held it for 1 year at an annualized 100% borrow rate).

High borrowing costs make it extremely important to time your entry correctly (using the 50/200 moving average crossover method that we have discussed). As we have seen, the stock needs to fall faster than your borrow rate, or you will end up losing money even if the trade itself makes money.

For example, if you have borrowed the stock at a 100% annualized borrow rate, and it falls 50% in 3 months, you are still OK. You make 50% on the stock short, and only have to pay 25% in borrowing costs (100%/12 months times 3 months= 25%), for a net return of 50% - 25% = 25%.

Even worse, when you are short a stock, it is possible for the broker to ask for the shares back at any time. If this occurs (and it almost always occurs at the worst possible time), you will need to cover your short (buy back the shares in the open market) wherever it happens to be trading on that day. When shorts are forced to cover by their brokers, a stock will typically rally significantly, so that you will probably be buying back your shares at a loss.

When you are just starting out, trade all of your stocks from the long side only. Exit your long positions when the 50-day moving average crosses below the 200-day moving average, and don’t try to get short.

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