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My Strategy for Successful Short-Selling

By Jeff Clark
Thursday, September 7, 2006

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 and keep reading Growth Stock Wire, you’ll have all the tools you need to make money on the short side of the stock market.
Best Regards & Good Trading,

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Market Notes
In the broken record department, drug giant Pfizer hits another new high… now up 18% in 2006.
Crude Oil falls to five-month low.
Silver staging a nice rally… up 30% from June lows.
In The News: Russia’s leverage in the resource sector.
Market Watch
Symbol Price
S&P 500 1221.53 +1.3% +10.1%
Oil 37.77 +1.5% -2.8%
Gold 135.20 -0.1% +13.4%
Silver 27.93 +0.4% +47.9%
US-Dollar 80.67 -0.8% +8.1%
Euro 1.32 +0.6% -12.1%
Volatility 19.39 -9.2% -8.2%
Gold Stocks 564.53 +1.3% +10.6%
10-Year Yield 3.00 +1.4% -9.6%

World ETFs
Symbol Price
USA 122.56 +1.3% +10.2%
Canada 30.44 +1.3% +13.8%
Russia 21.63 +2.3% +16.7%
India 37.73 +1.9% +20.0%
Israel 16.47 +0.9% +9.7%
Japan 10.58 +1.0% +7.4%
Singapore 13.88 +1.0% +19.2%
Taiwan 14.72 +1.6% +17.8%
S. Korea 56.56 +1.7% +22.8%
S. Africa 70.85 +3.9% +22.9%
China 45.06 +1.4% +0.1%
Lat.America 52.82 +1.4% +6.7%

Sector ETFs
Symbol Price
Oil Service 136.18 +1.5% +14.8%
Big Pharma 64.13 +0.6% -3.3%
Internet 72.13 +0.7% +22.3%
Semis 16.03 +2.1% +28.9%
Utilities 31.21 +0.3% +1.6%
Defense 18.51 +1.3% +10.1%
Nanotech 9.99 +1.3% +0.0%
Alt. Energy 9.95 +1.4% -4.4%
Water 18.31 +1.1% +12.2%
Insurance 16.07 +1.2% +18.3%
Biotech 20.58 +1.1% +27.1%
Retail 19.65 +0.1% +28.4%
Software 24.59 +0.9% +24.1%
Big Tech 53.73 +1.0% +21.9%
Construction 12.99 +2.1% +13.3%
Media 13.57 +1.1% +25.0%
Consumer Svcs 67.26 +0.8% +23.3%
Financials 54.87 +2.4% +5.2%
Health Care 64.22 +0.7% +1.3%
Industrials 63.25 +1.6% +19.7%
Basic Mat 73.57 +1.6% +21.6%
Real Estate 55.24 +1.4% +23.8%
Transportation 91.17 +1.4% +25.6%
Telecom 22.48 +1.1% +17.1%