The concept of short selling leaves many traders uneasy and the fact that more money can be made shorting the market does not bring relief.
Rationally speaking, fear supersedes greed, and prices always tumble down faster than they rise. Taking advantage of a fall is not only prudent but can make one richer much faster than going long and waiting for the stock to rise. Legendary traders have made fortunes short selling and history is full of such names. Jesse Livermore shorted the 1907 and 1929 stock market crashes and amassed multimillion-dollar fortunes. Nicolas Darvas, though an impeccable investor said way back in 1977 “I have never done it myself because I am not psychologically cut out for short selling. But I think markets have now changed their character so much that all experienced investors must seriously consider it. It is not for the proverbial orphans and widows though”.
But when should one consider short selling?
As a general rule, the best time to short is when the market is tanking. Any stock that has risen in a bearish market is a perfect candidate to short as it will eventually succumb to selling pressure and fall. On the other hand, a raging bull run is never a good time to short as even weak stocks start rising. However, company specifics should always be taken into consideration. A market that is choppy and is gone sideways is indecisive and should always be avoided.
Besides general market conditions, company and sector specifics should also be looked at. Stocks that have run up on trivial news are the best candidates to short as the bulls no longer find them lucrative and the bears jump in vehemently.
Irrespective of the general market conditions, another good time to consider short selling a stock is when it comes out with its earnings reports. If the earnings are good they will have already been factored in and all the good news is presumably over. Unless the company has exhibited phenomenal earnings, there is a better chance for it to fall soon after. This is also true for stocks that announce splits and other good news.
As the adage goes “Sell the news and buy the rumor”.