ABB Stock Market Trading continued, Short Sell

My last post gave a brief overview of some of the results of my past studies applied on a current trading plan using only long trades, buying then selling.

This time I want to look at the short selling of the same stock.

I have run into the odd time when I was forced to cover a short position due to the broker's requirements but those are few and far between enough that I don't think I'll worry about it happening that much. Worst case, if a particular stock is difficult to short, I will drop that facet of the plan for that particular stock.

Short selling is basically you borrowing stock from the broker in order to sell it to someone else. The value of the stock at the time of "borrowing" will be the same value that your buyer purchases it at. The purchase transaction is held by the broker until the stock is returned. The idea is that if the price goes down, it is bought back by you (covered) at the now lower price and is returned to the broker. Technically you have managed to borrow an expensive item, sell it only to buy it back for cheaper. You get to keep the difference. This difference is deposited to your account once the transaction is completed.

The old adage of buying low and selling high remains the same except that it is also true to say that you can sell high and buy low.

The reason nobody likes to do this, less than 2% of traders ever short sell a stock, is that the implication is that if the price goes up, the difference now comes out of your account. While buying a stock the value could drop to zero and you lose 100% of the investment, shorting has no limit on the loss, in theory. Once it is short sold, the price has no technical limit and the loss could be greater than 100% of the value of the stock.

Of course this is why stop loss orders are used and adhered to.

The other side of the argument is that typically price moves down are much faster than moves up and a short sale tends to be a much shorter duration trade than the long. This means that the price moving against you is not likely to get away very fast.

On to ABB and the application of the newer methodology.

I'll use the same ideas as the long trading plan but I'll skip all the proving of single entries vs staged entries and fixed profit targets vs VTSO partial exits from the last post. Suffice it to say that trading with the trend, multiple entrys, VTSO exits all work whether the price is going up for a profit or going down for a profit.

With a win rate of slightly higher than 80% and a return of $7.13 per share The idea of short selling a stock certainly makes it worth considering. Compared to the 162% ROI from the long side, 142%, is nothing to ignore particularly when the combined return is $15.26 per share or 305%.

Off to apply this same methodology to all of my other data charts to see, hypothetically, what my returns could have been.

Jeff.

A Comparison of Long vs Short Trades... Time Line

I always considered a short sell trade to be the faster moving trade due to prices dropping faster than they typically rise. While that may be true I did some comparisons between long and short trades for my sample of stocks and trades since June 2009.

For 21 stocks that I compared over the course of 434 trades completed there were 268 long trades and 166 short trades.

So I traded about 62% of the trades long.

Then I compared how much time I spent in the trades. I expected that I had spent near 70% of my trade time in the long trades, figuring that they are slower moving and there were more of them than shorts. I was surprised by the results.

I spent only 54% of my time in long trades.

I might suspect that the discrepancy may be due to varied targets, except that a short and long profit target are the same for trades in the same stock when the price is relatively the same.

Well, apparently this throws my assumptions about long vs short trade time frames out the window or perhaps the particular patterns and stats that I look for in my picks are more prone to slower moving down moves.

Jeff.

Forced Short Covering

Well, what a pain.

I just received a call from my broker telling me that I have to cover my SFG position because they have a buyer and they are short short inventory...at least they called instead of just closing my trade. I have heard of that happening in the past with other brokers.

This is the first time I have run into any issue with selling short and I had done a fair amount of it a while back, in fact it has been my favorite trade type.

So I have until 1400h to cover my 50 share position...at some loss.

I just placed a VTSO for 10 cents which gets me a better price than the high today at least.

I will track it as if I held the trade through...actually, they mentioned 1400h when I asked what the deadline was...perhaps they will just cover it at that time regardless of what I do. If that is the case I am best to leave the VTSO run and just let it go. I probably won't though as if I close it myself I might get an extra $5 on the trade...no big deal really but a buck is a buck better in my pocket.

This brings into question the efficacy of short selling as a trading strategy for some stocks. Obviously SFG is off my list for shorting now. I would have preferred had they bounced my initial short sell though... I would have just selected another stock to trade instead of SFG.

I think there may be a list ora method of finding out how thick the inventory is for shorting for future reference. I didn't think to ask the CSR at the time, I was just trying to wrap my head around having to cover a trade in a negative position...I was even giving some thought to adding to the position in the vein of the scaling in method earlier... glad I didn't do that.

Jeff.

The short sell

OK, it looks like I need to get into this one now. I was going to post a trade setup for Monday but it requires some explanation for the trade first.

The short sell:

Selling of a borrowed stock, the profit comes from a DROP in the price when you buy it back...opposite of a Long Trade in some respects.

Everyone knows what a long position is, buying a stock to hold until the price goes up for a capital gain or there are dividends paid to you as a shareholder. Basically buy low and sell high...pretty simple.

The short is more complicated. I've been asked to explain it a number of times so I think I can break this down easily.

When you deal through a broker you don't actually own any shares, they hold them for you and your account reflects the amount you have purchased. So the broker still owns them, this is important.

You short sell the shares to the market.

In a short sell you borrow some shares of the company you are going to trade from your broker. (Sombody has an account that has bought these shares but not always the case) For example, ABC stock is selling for $15 right now so you sell the market 100 of the broker's shares. The cash for the transaction is not yours, it is basically held in trust. So $1500 is held separately and the 100 shares show up as a negative quantity on your account.

In a short sell, as stated above, you are waiting for the price to drop to make your profit.

The price drops to $12. You decide that the $3 difference is enough and you now have to cover the short shares. Covering is buying the shares from the market to give back to the broker. In my trading software the "BUY" button is also the "COVER" button as they are the same transaction as far as the market is concerned.

You buy or cover the shares for $12 and pocket $300

The shares are covered for $1200 total which can be considered as deducted from the $1500 held in trust. You give them back to the broker. $1500 was held from the sale, $1200 was the cost to "cover" or buy back the shares from the money held in trust so you get to pocket the $300 as profit.

The "short" version is that you short sell the shares for $15 per share, then cover the shorted shares at $12 per share and get to keep the $3 per share.

Three things to remember as you hold a short position:

1) holding over the ex-dividend date you will be responsible to pay the dividends to the broker

2) if the stock splits, you will be responsible for buying the appropriate number of shares to cover the number the split was (2 for 1 you need to buy 200 instead of 100...at whatever price you can)

3) last but certainly not least, if the price goes up you lose the difference. This can have serious consequences unless you depend on your strategy.

This one is sometimes hard to get. I understand that only around 2% of people investing or trading in the U.S. have ever even done a short sell. It is misunderstood. Most of my trades have been short sells and I like them.

JD.