What is Short Selling? Part 2 – How to Short Sell Trade Analysis


Rather watch than read? Watch the video at the bottom of this article.

We already covered “What is short selling?” now we’re going to cover an actual short sell trade that I made in one of my accounts.
Here you can see a chart of Hewitt Associates on the NYSE, symbol HEW, and you might be asking, “Where and how did I find this stock?” Well, it was very simple.

All I did was some simple scanning, using Stockcharts.com scanning tools to build a watch list and once I had this stock on my radar, I simply waited for an opportunity to present itself. There was definitely some major pain here. A lot of people felt a lot of pain with this big red candlestick, with volume. It closed at an area of support, rallied off of there a little bit, created a new resistance point, which actually is a previous area of support. Now it’s acting as resistance.

One of the things that caught my eye as well was the fact that the 20 period and the 40 period moving average crossed downwards. Now it’s really indicating that the bears have taken control and you might want to start looking for short opportunities. After this minor resistance has been established, I’m looking for another opportunity to short at or near that area. You can see here, it actually tests that resistance, comes back down to that previous area of support, so you got a very strong support area here. It rallies off of there again and goes back to roughly the same area of resistance. This is where I’m really starting to watch, and actually, on this exact candlestick – you can see a shooting star candlestick pattern showing up here – this is when I’m zeroing in for the kill and getting ready to short sell this stock.

Entered position at $26.85, stop $27.55. Covered half at $25

Let’s take a look at the trade on the next chart. Here we have our shooting star candlestick and my entry point is on June 7th at $26.85. Why $26.85? Well, we have this candlestick pattern where it trades all the way up to a high level, very near the resistance point, and then starts to come back downward again. Now I’m immediately shifting my focus to a shorter time frame, getting ready to pounce on this stock. I finally decide to do so at $26.85, which is $00.10 below the opening price of the day, that really confirms to me that this is weakness and that the bears have now taken control away from the bulls and are ready to take this stock lower.

I purchase 600 shares and I have a comfortable price target of $25.00, which is an area of major support. Now why 600 shares? Well, my portfolio is large enough so that I can sustain a larger position, but I don’t want to take on more than 30 percent the size of my actual portfolio in any one trade. So, I’m actually only risking with this stop loss, $420.00, not including commissions, and that is calculated based on the fact that my entry is $26.85, my stop loss is $27.55. That is $0.70 times 600 shares, which is going to mean, even if it goes to my stop loss priced at $27.55, the most I’m only going to lose is $420.00 on this trade. This is a very small and very comfortable amount of money if you have a large portfolio, so the risk is limited.

After entering this trade, the proceeds of $16,110 is then placed into my account until I actually buy back the shares, hopefully, at a lower price. In this case, that does happen. The price falls quite nicely so on the 13th of June, which is the long red candle. I hit my price target of $25.00. I sell half my position at $25.00. I get back $7,500.00 here, cost for the first half of the trade and I’ve now lowered my trailing stop loss to $25.86, the $25.86 is a full $00.25 above this day’s high of the day. I’m giving myself a $00.25 cushion plus the difference in the closing price and the high price.

Pretty comfortable spot to be in and I’ve already made a profit on the front half and if you noticed, $25.86 is below my entry price of $26.85. Now I’ve locked in a profit on the back half also.Essentially I have a free trade on the back half and this eliminates the emotion of greed and fear, because I’ve already made my profit. That appeases the greed demon and my fear is now gone because I’ve locked in a price target that’s going to guarantee me a profit on the back half.

Things continue to go very well here. We have this huge down day again, with volume, on this candlestick here. I have the Trading Master Plan 5xMA trailing stop rule in place. In this case, the calculated stop loss was $22.44. However, the stock did not quite hit that price. It actually had a low of $22.95 for the day, which is very close and I was definitely ready to go for the next day, hoping to hit that price target.
I actually re-adjust the following day using the same 5xMA rule and because the moving average has now fallen even further. The 5xMA rule has created an even lower price target of $22.25 and this time it does hit, I sell the back half, 300 shares at $22.25 for another cost of $6,675.00 back. By the way, the low of the day was only $22.14 for that day, so we were only $0.09 away from the low on that day.

If we’re going to do trade analysis here, we would see that the proceeds of $16,110.00 less the cost that we got back when bought the shares back. Had a net profit of $1,935.00, which translates to 12 percent in only 8 trading days. This was a very productive and very quick trade. . I took a very limited risk of a little over $400.00 and I have quadrupled that with a gain of 12 percent in only 8 days.

Just a note on this chart here, the actual low a couple of days later was $21.66. I’m not too worried about it. I mean, I did fantastic in this trade. I managed it properly throughout, continued to stick to my trading rules and do you think I’m really worried about not getting $21.66? You know, the trade went extremely well. Does every trade go this way? Absolutely not. This is obviously a very good example that I’m using here. I had several trades. This is one of my better ones for the last month or so. Certain trades are going to stop out. If things had gone against me and stopped out immediately, I would’ve lost $400.00. No big deal. Move on to the next play.

This is where money management really saves you. It keeps you in the game so that you can get these types of trades more often and then hit nice home run trades. I wouldn’t say this is a home run, but a very good trade that’s going to build your portfolio, really create that long term wealth that the majority of people are looking for.

Dave

Founder of Market Insiders Club.com. President and CEO Dynamic Wealth Financial Inc. Author of Trading Master Plan

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Brad - September 24, 2010

Great article! I think there’s always something missing for people and it’s being able to ride the downside.

Looking forward to hearing back from you.

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Dave - September 24, 2010

I couldn’t agree more Brad. You need to be able to trade from all sides including sitting out when things get too hairy.

Dave

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