Short Trading Strategies

Trading short on the market requires that you sell a stock or CFD and subsequently buying back the stock (known as covering your position).

Blamed for the Wall Street crash in the 20s, short selling is something that traders seek to do in crashes, be it a stock market crash in general or a falling price of an individual stock.

And with CFDs, shorting has become even more widespread as traders seek to profit from both downs and ups in the market.

After all, if you can profit when the market is going down, then this adds to your overall returns.

So what are some short trading strategies?

Short Selling Strategies

1. The first step is to identify your target stocks.

Which stock CFDs are available to be shorted?

This has to be the first question that is answered. Depending on the market that you're trading, whether it is the ASX, US, UK, European, Singapore or other exchange, there will be a list of shortable stock CFDs according to each individual CFD provider.

This list may change over time.

2. Identify a trading style.

Are you trading a trend following system, a mean reversion system, or other system?

Once you know, this will determine the next steps...

3. Identify the trigger to enter short

If you are doing a trend following system on the short side, you will need to have a trigger, based on price action or indicator or a relation betwen the two.

If doing a mean reversion, you are looking for a significant deviation or displacement from the mean in terms of stock price. taking into account the stock price's usual daily flcutuation and volatility, and comparison to this is a significant movement.

4. What are the trading rules for entry?

Rules include the minimum price of the stock, the minimum turnover, the recent trend in the stock for trend followers, as well as for mean reverting traders, recent volatility changes, and size of deviation from the mean.

5. What are the rules for selection of triggered stocks?

In many systems there will be more stocks triggered that you can get into. So how do you pick which ones to place orders for. YOu will need to find a parameter that you can sort the triggered stocks by to select the top ones to enter.

6. Risk management?

What is your trade size, what is your maximum number of trades, and pyramiding (how many trades can you ahve in the same stock)?

7. Fixed stop?

How do you define your fixed stop? Based on price action or an indicator?

8. Trailing stop/profit target?

Which of these do you have, and sometimes one can act as both. You will need to define the parameters in your trading strategy the rule for buying or covering your position.

9. What are your backtesting results?

A major pitfall here is using the same list of stocks from the current day to backtest over years of data. The reason why this will nto be accurate is that the shortable stocks change over time. If its the top 200 stocks in your exchange that can be shorted, then the list of tradable stocks shoudl change as the backtesting program looks at each quarter.

10. Do you want to trade one or two short systems with one or more long systems?

This strategy for trading short aims to improve the equity curve of your trading system. One system can produce a bumpy ride and so can another, but combined may produce better and more consistent results. Remember that you want the short side of the system to remain quiet when the market does not suit it, eg during a bull run for a short trend following strategy. However the mean reversion short system can do well in a rising market. Put them together and examine the profits, drawdowns, and other parameters.

So a short system on its own is a useful tool, but combinations of short and long can produce trading results that are more consistent, ideally a combination of 2 good systems together.