LIVING OFF DIVIDENDS & PASSIVE INCOME

From my previous posts, you can tell I’m losing money being short on a stock that is defying all expectations and has gone up 20% since the day I jumped in. I’ll admit, I’m not too bright and always forget to follow advice which I know to be true. Here’s a strategy that I should try and remember well.

My Strategy for Successful Short Selling
by Jeff Clark

When I first started trading stocks, I did so almost exclusively from the long side… only buying stocks.

Through a series of trials and errors, I developed a three-pronged approach for what constituted a good stock to buy:

1. Ridiculously cheap valuation.
2. High degree of pessimism surrounding the shares.
3. Price action that had just turned up following a long decline.

As simple as this buying strategy might seem, it has produced superior returns… and it’s the strategy we follow in the Big Trend Report .

Logically, then, it makes sense to use a similar three-pronged approach to betting on a stock falling – called shorting.

1. Ridiculously high valuation.
2. High degree of optimism surrounding the shares.
3. Price action that has just turned down following a steady incline or parabolic rise.

Let’s look at each element individually…

1. Ridiculously high valuation.

We all understand that, ultimately, earnings drive stock prices. Consequently, the P/E (price/earnings) ratio is the best gauge with which to measure the ridiculousness of a stock’s valuation.

If you’ve found stock with a P/E ratio 50% higher than the industry average, or more than 50% higher than the company’s historic P/E ratio, then you might have a good short sale on your hands.
2. High degree of optimism surrounding the shares.

If every analyst on Wall Street loves the stock… If the anchors on CNBC seem to be mentioning the stock every hour… If all of your friends are talking about the fortunes to be made by owning the stock… Then it’s probably on my list of short sale candidates.

This concept is easy to understand. If the whole world is in love with a stock, and if everyone who wants to own the stock already does, then who is left to push the price higher? If there’s no one left to buy and to push the stock higher, then it only takes one seller to shift the momentum in the other direction.

3. Price action that has just turned down following a period of steady incline or parabolic rise.

Just as it doesn’t make much sense to jump in front of a moving train, it doesn’t make much sense to short a stock as it’s moving higher.

Rather than trying to pick a top in a stock, it makes far more sense to wait until the price action has turned lower – and in the early stages of a downtrend. For me, that confirmation occurs when the stock trades below its 50-day moving average.

Stocks in which the upside momentum is strong will hold above their 50-day moving average lines. Failing to hold above that line is an excellent early indication the momentum is shifting to the bearish camp.

You see, all of the Wall Street hype, all of the CNBC promotion, and all of the persuasive opinions of friends at cocktail parties creates big opportunities for us to bet against over-hyped stocks.

If you stick with these three guidelines, you’ll have all the tools you need to make money on the short side of the stock market.

Best Regards & Good Trading,
Jeff

WCI failed all three tests, its already dropped signficantly and there’s a tremendous amount of pessimism surrounding the stock. I should’ve stayed away! I’m not cut out to trade, which is why I got into real estate in the first place. Like my friend who’s a financial planner says, “Stick with what you know!”.

• Bear fund managers warn against short sales Here's an interesting article from Bloomberg. I don't agree with it, but then again I didn't make 74% returns last year, nor do I run a multi-billion dollar fund. Steven Leuthold, whose Grizzly Short Fund makes money for investors by betting companies will fail, says he wouldn't invest in his......
• On Going Naked In a previous post on WCI, I had mentioned that I had sold some March 2007 Calls. When you sell a call and you own the underlying stock, its called selling (or writing) covered calls. In my case, where I don't own the underlying stock, its called selling naked calls.......
• Oil Break $115 Per Barrel Oil just broke through $115 per barrel today. While this may come as a shock to many , I've been preparing for it for the past 2 years. All the signs of an oil shortage have been visible in the media, but most people have either been ignoring it, been......

• Index Funds: Why Choose Anything Else? This is a guest post from Mike Piper, who blogs at The Oblivious Investor, where he reminds readers that investing doesn’t have to be complicated or stressful. Mike is a long-time GRS reader and the author of Investing Made Simple. Like many other investors, J.D. and I are fans of......
• Negative Dollar Cost Averaging One of the most basic tenets when you are saving for retirement is to dollar cost average your investments by contributing the same amount of money each month (or quarterly or weekly, depending on your preferred investment schedule).  By doing so, you'll end up purchasing more shares of the (usually)......
• Piqqem: Crowdsourcing Stock Picks Last week, I was contacted by Piqqem. Then wanted to tell me about their service and get my thoughts. I have to admit that I didn't find the Piqqem site that interesting. I love the idea of crowdsourcing, but it seems to me that the stock market is already and......

[All content is copyright of Living Off Dividends & Passive Income]

Random Posts

• May 26, 2008 -- Renting Vs Buying: How To Live Beyond Your Means!
• July 20, 2007 -- Time To Jump Into Shipping & Steel Stocks?
• July 23, 2008 -- The World’s Most Expensive House
• August 30, 2006 -- The Joys Of Not Working
• August 1, 2006 -- And The Winner Is Inflation!
• March 30, 2006 -- People Fleeing San Diego!
• May 9, 2006 -- Got A Face Lift!