The 7 Great Times To Make Money Shorting Stocks

The recent 3500 points plunge of the Dow Jones Industrial Average from the top to its recent low in just a couple of days have left many terrified. Many have also lost a lot of money but did you know you could have profited by shorting stocks?

What if you had shorted stocks instead of holding on to them in the hopes that they will rise again? You could have made a lot of money very fast when the market collapsed.

Stocks drop 3 times faster then it rises. When everybody is panicking, there is not much that will stand in your way. Everybody is selling and selling and selling and this helps to send stocks prices lower by 5%, 10% and even 20% in a single day.

When stocks collapse like this, many will see their portfolio shrunk by half. But there will be a group of people who will profit from this crash.

Welcome to the world of Professional Trading!

What Is Short Selling And Why You Should Short Stocks

If you are new to the stock market, chances are you will only know 1 way to make money in the market. You buy low and sell it higher and then you pocket the difference which will be your profit. 

Let's say you think that Microsoft will go from $90 to $95. You buy the stock at $90 and when it goes to $95 you sell it to get a $5 profit. When you buy a stock and sell it at a higher price we call it "long".

Shorting a stock is the exact opposite of "long" a stock.

You profit when the price goes down.

For example, you think that Microsoft will go down from $95 to $85. So you short the stock at $95 and buy it back when it touches $85. Buying back a stock after you short it is known as "covering your shorts" or what traders say..."cover". You profit $10 from that trade.

It may sound a bit weird and even insane to learn that you can make money when the market falls. This will be strange to many people at first but eventually you will know that this is a great way to profit when the market declines.

I will not go into the little details of how a short sell work. Just remember this thing:

  • You will make money shorting stocks when the stock goes down

The stock market will go through 4 stages again and again and again. Nothing is new under the sun and history repeats itself. The 4 stages are:

  • Stage 1 - Market Basing
  • Stage 2 - Bull Market / Uptrend
  • Stage 3 - Market Top
  • Stage 4 - Bear Market / Downtrend

Most people only know how to make money when a stock is in an uptrend. But I think it is time for you to learn how to profit when the market tops out and enter into a downtrend. Instead of fearing a correction or a crash, you will learn how to navigate out of this mess and make some money out of it.

In this article, I will not talk about short selling strategies. There will be other articles that will teach you individual strategies. Here, I just want to show you the 7 best and greatest times where you can make money by shorting stocks. When you see a stock or the market in these 7 areas, then you know the market is about to collapse.

Let this article be a foundation for you. The solid foundation that you will get in this article will enable you to know some of the best times to implement your short selling strategy.

The chart above is the daily chart of the Dow Jones Industrial Average Futures. The Dow has been climbing up steadily until it suddenly decided to take a plunge. It was almost like jumping off a cliff. The fall wiped out billions of dollars in equity wealth for investors in America and around the world.

Just imagine if you had learn how to short stocks. You would have made a nice profit as the Dow collapsed.

An Example Of Short Selling

For those who are new, you might still have problems trying to understand how short selling can make you money. So let me walk you through an example so you can understand this special way of making money.

Okay, let's say you learned about the topping tail bearish reversal pattern and you decide to short the next stock that forms this pattern. As you scroll through some stocks, you notice that Apple's stock formed a topping tail pattern in the daily chart.

The chart of Apple above with a topping tail is what you see.

You figure out that you will short Apple when it trades below the low of the topping tail. For safety purposes, you put a stop loss at the highs of the topping tail.

Therefore,

  • you short Apple at $176.80
  • you put a stop loss at $179.50
  • the difference between the entry price and stop loss is $179.50 - $176.80 = $2.70
  • you decide to risk $5000 in the trade
  • by dividing $5000 with $2.70 you short 1851 shares of Apple

You happen to have chosen the correct trading candidate and immediately, Apple dropped. After 3 days, you saw that Apple has drop a lot. You decide to cover it tomorrow but the next day, Apple dropped even lower. So you thought to yourself...if Apple can drop so much so fast it might drop to the 200 MA.

You remembered reading somewhere on Dstockmarket.com that the 200 MA is a very powerful support. Therefore, you make the decision to close the trade when Apple falls to the 200 MA. After 9 days from the entry point, Apple drops to the 200 MA and you close the trade.

How To Use The 200 Day Moving Average

  • You close the trade when Apple is at $158.90
  • Your original entry price was $176.80
  • Therefore your profit per share will be $176.80 - $158.90 = $17.90
  • When you multiple $17.90 with the 1851 shares of Apple you shorted you get a total profit of $33,132
  • This is an awesome risk reward ratio. You risked $5000 to make $33,132. (minus commissions of course)

Not bad for 9 days work!

That my friends is how you make money shorting stocks. Everyday there will be stocks that are going down. Every week there will be stocks that crash. If you know when and where are the great times to short stocks, you can rake in profits consistently by shorting stocks.

In this article, I will show you the many areas that are conducive to short stocks.

1. When A Stock Or Index Has Run Up Too Much Too Fast

One of the best times to short stocks or indices is when they have run up too much too fast. If your stock has run up too much, it is not sustainable. An index that runs up too much is also not sustainable.

The example of the recent plunge in Dow Jones in February 2018 is a great example of how traders can profit from an index that has run up too much too soon. An index that runs up like this:

  • Does not have much support areas
  • Have lots of voids in the run up to enable a smooth short

Take a look at the daily chart of the S&P 500 futures above. Notice how in early 2018 the stock market rose non stop without pausing. Support areas are actually congestion areas that formed in the past. Because the bull run was so swift, it created no congestion areas. 

Therefore, when the stock market plunged, there was no reference points for traders to look at for support. What goes up smoothly without much pause will enable stocks to go back down smoothly. There were some congestion points at the 2680 area. But because the plunge was so terrifying, it was not able to stop investors from selling.

The S&P 500 only managed to find support as it drop to around 2560. This is where the rising 200 MA is.

The next time you see an index or stock run up too fast too soon, always beware that it may fall just as fast. Traders who know how to short should also pay attention to it. You might just find a great shorting opportunity.

Let's take a look at another example which is the daily chart of AMAT. AMAT had a really nice run up since Sept 2017 up to November 2017. This kind of run up makes it more and more risky for the stock. Anytime a stock has a run up, the odds of a correction increases as time goes by.

The stock was actually trying to consolidate. It also tried to break higher but it immediately form a very big negative bearish bar. A big bearish bar after a nice run up is a big big warning of a potential correction. 

You can read more about this big bearish bar and its implications in this article How To Spot A Top In Your Stocks Using The Angry Bird.

AMAT eventually broke below the 20 MA and also below the consolidation. This setup the stock for a very nice short trade. The lesson here is this...

Whenever a stock runs up too much, start to be aware of weaknesses. It is very rare that a stock will not correct. The correction will provide an opportunity for you to short the stock for a few days to a few weeks.

2. When The Stock Breaks A Long Term Uptrendline

A trendline is a very simple tool that professional traders use. They are simple but they are extremely useful. Nowadays, many people like to have complicated indicators to tell them what to buy and what to sell. They even trust an indicator that costs them $3000 a year rather than what experienced traders use.

Trendlines can often tell us when a trend is about to change. In fact they are one of the first signs of when a stock is about to get into trouble.

If you are not sure what a trendline is fear not. The image below shows what a trendline is.

how to draw a trendline

A trendline is drawn by connecting the lows of a stock that is in an uptrend. Because the stock is in an uptrend, we call it an uptrendline. Uptrendlines can be subjective because ultimately, each trader will draw it a bit differently. These small differences does not really matter.

What is most important is you connect as many lows as possible. An uptrendline that connects 5 lows is better than an uptrendline that connects 3 lows. Some people use the uptrendline to gauge the strength of a trend. As long as their stock is above an uptrendline, they consider the stock to be healthy.

When a stock breaks an uptrendline, it can often signal the beginning of a change of trend. Sometimes the stock can drop very fast when they break an uptrend line. Therefore, this presents an excellent opportunity for traders to short stock.

That is why you should learn to draw uptrendlines in a stock and spot the breaking of trendlines.

Let me show you a real live example of how the breaking of an uptrendline caused a stock to plunge. The chart above shows the daily chart of ADI. ADI had been going up very nicely for 2 months.

We can draw an uptrendline by connecting the lows of each correction. Notice how the stock continued to climb higher when it stayed above the trendline. In late January 2018, ADI broke below the uptrendline. This was the beginning of the drop. In just a few days after breaking the trendline, ADI lost all the gains it made in 2 months.

That is the beauty of shorting stocks. Stocks tend to go down 3 times faster than they go up. In this case, the plunge was light speed faster than its ascent. The speed in which money can be made is why many professionals prefer to short stocks rather than long stocks.

It takes a lot to make a stock go up. But it only takes a little shove to send a stock free falling.

What happens if an index or the ETF of an index breaks an uptrendline?

Well...

You better be triple cautious and triple bearish when an index like the S&P 500 breaks an uptrendline. While the breaking of the trendline might only mean slowing bullish momentum, you can never be too careful.

The chart above shows us the daily chart of the SPY which tracks the performance of the S&P 500.

Notice how SPY broke an uptrendline? Notice how SPY went up too much too fast? The index was overextended! When you combine the fact that SPY had run up way too much and then breaking an uptrendline, this told us that it was ripe for a fall. Experienced traders will be very cautious when they see these warning signs.

Some will get ready by looking for short setups.

Do remember that this article only covers the best times to short stocks. To short stocks like a professional trader you need to learn some short selling trading strategies. I will try and write some short selling trading strategies in the Trading Strategies page on this website so do come back and check them out in the future.

3. When The Stock Forms A Topping Tail In Daily/Weekly/Monthly Charts

If the topping tail sounds familiar, its because I have mentioned about it in the earlier example of Apple above. The topping tail is a simple yet powerful Japanese Candlestick pattern that warns traders of a bearish move.

This pattern is easy to spot even for beginners. You just can't miss it because it is so obvious. There is a body with a very long tail at the top. Its just like looking at the sky and seeing very dark clouds which warn you of impending rain.

So whenever you see a topping tail appear in any stock or index, you better start paying attention. It might or might not fall but its best to start being bearish.

Right here in Dstockmarket, I separate the topping tails into two categories. If a pattern has a small tail, I call it the normal topping tail. When the pattern has a very long tail like my Siberian Husky then I call it a super topping tail.

This is the kind of topping tails that you want to see when you consider shorting stocks. It tells us that the stock has absolutely gone ahead of itself and is rejecting to go higher. Which is why they could not close near the highs but close near the lows.

The chart above shows the daily chart of ACAD. Notice how a beautiful topping tail preceded the quick drop in the stock? Even before the appearance of the topping tail, the stock has failed to make a higher high.

Instead, the stock broke below its 20 MA which hinted of short term weakness. Then it broke below the 50 MA which hinted of a mid term weakness. Not only that, the stock formed a bearish cross where the 20 MA cross below the 50 MA. All this plus the topping tail was warning of a potential plunge in the stock.

The stock dropped below the consolidation it was making and continued to move lower rapidly. What can you do if you had all these knowledge?

Well, short the stock of course!

Pay attention the next time a stock forms a topping tail. Then looks for signs of bearishness.

Topping tails are not only bearish for daily charts. In fact, if you see a topping tail happening in any time frame, you can expect weakness in the stock for that time frame. The chart above shows the weekly chart of AIG.

Notice the topping tail that appeared around August 2017?

The stock went lower right after the appearance of the weekly topping tail. It also broke below a weekly long term uptrend line. These two combinations was enough to send AIG lower 5 weeks!

Imagine if you had shorted the stock. You would have made a very nice profit from AIG's decline.

4. When A Stock Suddenly Gaps Down 

Gaps are voids in a stock chart. When a stock gaps down what happens is the stock opens significantly lower than yesterday's closing price. There is not trading in between yesterday's closing price and today's opening price. 

An example of a gap is when a stock closes at $55 yesterday and opens at $54. The difference is $1 and we say that the stock has gap down $1 today.

Gaps happen for many reasons. The company may have bad news. Or the company has bad earnings. Or it could be for any reason. The important thing to know is that gaps will cause a lot of investors and traders to lose a lot of money. When people lose a lot of money, they will panic and start selling their shares.

This causes an abundance of supply. Since supply is more than demand, the stock will naturally go down rapidly for many days. A smart trader will look for opportunities to short the stock.

Some gap downs can produce a very very fast big return in just a few days. Take a look at the example above. Isn't a gap down powerful?

First of all, ALK is in a bearish downtrend. How do we know that this stock is in a downtrend? Well, the fact that it is below its declining 200 MA tells us that this stock is bearish. Any rallies is suspicious and therefore, the experienced trader will look for opportunities to short this stock.

Yes some traders will look for stocks that are below their declining 200 MA and wait for shorting opportunities. That is why you should be alert to stocks that are trending down and below their declining 200 MA. When the stock is below its 200 MA, this tells us that the long term health for this stock is not good.

ALK was trading sideways forming a consolidation back in October 2017 when all of a sudden, the stock gap below the consolidation. Consolidation are continuation patterns and when the stock breaks below the pattern, it told us that the stock did not want to go up. Instead it choose to move lower.

The stock also gap down below its 20 MA and 50 MA all in one stroke telling us that it is now unhealthy in the mid term and short term.

Some traders would have shorted the stock right at the open. The combination of technical factors told traders that this is a very bearish stock. Which is why ALK drop furiously for 2 days. The stock continued to drop for a few weeks.

Murphy Oil is another great example of why you should short stocks that gap below a consolidation pattern. Notice how MUR ran up quite a lot in a short period of time. When a stock has run up a lot, we can expect two things.

Either the stock will consolidate and go higher or it will correct. Right up to the day before it gap down, MUR was consolidating very nicely and looked like it was going to break out higher.

I think many people would have expected the stock to breakout higher and continue the run up. So, this in fact created a bullish psychological effect to participants of this stock.

What happens when the stock gaps down below the consolidation? Suddenly everyone's bullish expectations for the stock was dashed. A bullish expectation not fulfilled immediately turns bearish. Not only that, some smart short sellers would have noticed this and help the stock go lower by shorting the stock.

The stock dropped below the 20 MA and then dropped below the 50 MA and now has dropped below the 200 MA. This is some powerful stuff isn't it? Just like a child who expects an iPad but instead gets a Samsung suddenly yells and behaves badly.

The next time you see a stock gap down, pay lots of attention.

Try and figure out if the stock is bearish enough for you to short. If support areas are far away, the odds of you coming up with a nice short trade increases.

5. When A Stock Is Extremely Overbought

The concept of overbought oversold has some value in the world of trading. If something is overbought, it means there is so many people buying it that there might be nobody left who can or want to buy the stock.

When that happens, the stock will have a temporary correction.

If a stock is overbought in the daily charts, it is likely to correct for a few days to a few weeks. If a stock is overbought in the weekly charts, it may correct for a few weeks to a few months.

To short a stock purely because it is overbought can be very dangerous. That is because when a stock is in an uptrend they can be overbought for a very long time. Some stocks can remain overbought for months without seeing a meaningful drop.

Therefore, it is important for the trader to know what type of overbought situation are suitable for shorting.

There are 2 kinds of overbought that are safe entries for short sellers.

  1. A parabolic type of overbought
  2. Overbought at resistance levels

The first type is where the stock has run up so much that the move looks like a parabolic move up. If you can catch this kind of tops, you can often make a lot of money risking very little. A parabolic top happens when the market is in a euphoria. What happens next is a big big crash that can send the stock lower by a lot.

The second type is where the stock gets overbought as it trades near resistance levels. You can use some oscillators to determine overbought levels in the stock. The combination of overbought readings and the fact that the stock is hitting resistance can be powerful enough to send a stock lower.

ARNC had a very very nice run up. It came to a point where the stock's run up became a little parabolic. The stock managed to rest by trading sideways. However, that was not enough. The stock broke below the consolidation box and this started the sell off in this stock. Another gap down accelerated the stock's downfall.

Notice how the stock was already very overbought for a long time.

The monthly chart of oil prices shows how a financial instrument can be extremely overbought with a parabolic move up. A parabolic move up is not sustainable and usually hints to a top in the financial instrument. Towards the top of the move, a big red candle appeared which almost engulfed the previous candle's body.

This was a bearish candlestick pattern in the monthly chart. Traders can actually use the monthly bearish candlestick pattern to short oil. Look how oil prices fall drastically. It was a very bad crash for oil prices.

This example shows us that not only stocks get overbought. Any financial instrument that humans invest in will go through boom and bust. The latest example will be cryptocurrencies like Bitcoin.

ACAD had a very nice run up but it became very overbought in the weekly chart. The stochastics gave a very overbought reading. Notice how the stock was hitting a resistance area when it become overbought? This perfect combination give traders an opportunity to short the stock.

If you look carefully, the stock was actually forming a weekly topping tail as well. All these are hints to traders of a possible decline in the stock.

6. When A Stock Breaks Below A Consolidation

A consolidation is a period of rest for a stock. During this period, the stock trades sideways in a relatively tight manner. You can find consolidations in an uptrend and you can find consolidations in a downtrend.

Where it is found does not matter.

The important thing is that the stock drops below the consolidation.

There is something special about a stock that is in an uptrend dropping below a consolidation. A consolidation in an uptrend is often viewed as a pause before the stock continues to move higher. So there is always a bullish expectation. What happens when the stock drops below that consolidation?

All the hopes of a bullish move up vanishes and the entire trading community starts to turn bearish on the stock. That is a good time to short stocks.

The chart above shows how PHM formed a consolidation in an uptrend. I believe that most investors and traders were expecting the stock to continue moving higher after the consolidation. Then all of a sudden, the stock gap down below the consolidation.

This immediately triggered some negative emotions among participants of this stock. Not only did it gap down below the consolidation, the stock also went below the important 50 MA. This is bearish.

Notice how the stock went down for about 2 weeks and has stayed around that area for some time. If it wasn't for the psychological 200 MA nearby, the stock might have dropped a bit more.

RSPP is another stock that shows us how a failure to breakout of a consolidation can have negative consequences for the stock. There are some important lessons here for you to learn as well.

Well, the stock dropped below the consolidation. Now that you know about this phenomenon, you will naturally think that it is bearish. But for those who do not know about this, they will look at the 50 MA and the nearby support and think that the stock is going to be alright.

However, look at how the stock slashed through the 50 MA and the support area. The stock also slashed through the 200 MA. When a stock drops below the consolidation in an uptrend, a lot of negative emotions come in.

Bullish expectations that were dashed immediately turns into a bearish nightmare for most people. That is why the stock had enough negative strength to slash through the 50 MA, price support and the 200 MA. Do remember that the consolidation area has now become a resistance area as well. Therefore, traders will consider that area to be a hindrance or a ceiling.

7. When A Stock Forms A Bearish Reversal Pattern

A bearish reversal pattern can comprise of a bearish Japanese Candlestick pattern or bearish reversal chart patterns. I have shown you one bearish candlestick pattern above in the form of a topping tail.

However, there are plenty of bearish reversal patterns which you should learn. Some traders like to short stocks using bearish candlestick patterns.

Some of them include:

Chart patterns can also be very useful. Some bearish chart patterns are:

I won't show you an example of a bearish Japanese Candlestick pattern because I have shown you earlier in the chart of Apple and in the topping tail section. What I want to show you instead is the power of bearish reversal chart patterns when it comes to shorting stocks.

The reason why bearish chart patterns like the head and shoulders top, double top and triple top works so well is because these are classic patterns that appear again and again in market tops. Whether they are long term tops or short term tops, we can often see them appearing again and again in indices and stocks.

The chart above shows the 60 min chart of QQQ. For those who were observant, they would be able to see a 60 min head and shoulders top. This pattern appeared right before the market plunged in early February 2018. The plunge was so terrific that it hit headlines all over the world. When you have a drop that erased billions in equity, it always get in the news.

How can traders profit from that plunge?

Well, they could have shorted the QQQ or the Nasdaq Futures or the S&P 500 or the Dow Jones. For those who chose the QQQ, they could have shorted the QQQ when it drop below the neckline. Many short sellers will enter when a stock breaks below the neckline of the head and shoulders pattern.

After the QQQ break below the neckline, the drop was swift and fast. Those who shorted the markets and stocks were able to make money as the market goes down.

Shorting Stocks In An Uptrend 

I think if you are observant you will realize by now that all these areas for shorting happens when the stock or index is in an uptrend.

Welcome to the world of Professional Trading!

What you have learned here is the areas to short stocks when they are running up. You now know the areas to short stocks just before they collapse.

Some books will teach you to short stocks that are in a downtrend. Well actually that is another great place to short stocks as well. I will write about how to short stocks that are in a downtrend in the future.

The information contained here is useful for you to know how to find places to short stocks when they are about to turn bearish. In fact you will be shorting the stock near the top.

Conclusion

This may be a very long article that highlight 7 great areas to short stocks. I know this might be a lot for the newbie so do take some time to read it again and again. I will put article into a PDF Format as well. You can get it in the Ebook section when it is ready so you can take it anywhere with you to read on your Ipad or Tablet when offline. 

Since you now know 7 great areas to short stocks, you might also be interested to learn about the 7 Best Times To Buy Stocks For Short Term Trading. You can download it in the Ebook section.

That way you will be an all rounded trader who knows when are great times to buy stocks and when are the great times to short stocks.

Thanks for going through this entire article. You deserve a pat on the back. Feel free to share this article with anyone who may benefit from this information.

Happy investing and trading!

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