Tag: Trading strategy

All trading-strategy related articles are found here. Educative, informative and written clearly.

Low-risk Options Trading Strategy

These low-risk options trading strategies are commonly used for trading stocks but they are suitable for any market you would like to trade.

By Guy Avtalyon

Low-risk options trading strategy should be cleverly defined. It is a whole different story from any other trading. Options trading means a bit more security. How? Instead of estimating what price the particular asset will hit, you can enter the opposite position and speculate which price it will not hit. Sounds weird? Absolutely not. Yes, for some people this whole world of puts and calls may sound scary but low-risk options trading strategy is one of the easiest ways to make money.

For example, you can take a position called a covered call which is one of the safest. So, instead of talking a lot, let explain this low-risk options trading strategy.

Covered call as low-risk options trading strategy

This can be an excellent method to increase your profit. This strategy means to sell the right to buy a stock that you own, at a specific price, on a determined date. You’ll receive the premium when selling a contract, and you’ll receive it immediately. The best part is that you’ll profit even if the stock price doesn’t change, no matter if it stays the same or drops. The buyer, to whom you sell the contract, can make a profit only if the stock price increases within the specified time frame.

So, you’ll have better chances than the buyer of doing well. And, don’t forget this, you’ll get the premium. You can use it to protect your trades in other positions you take if they are risky.

For you, that are new in this field, use the stock you already hold. In case you lose on the contract you’ll have the stock to simply give. Keep in mind that the call is only valid until the expiration. If the stock price stays below the strike price, then you’ll keep the profit or cost reduction. You can do it over and over again with the covered call. In this way, you’ll continue to reduce your cost and increase protection against unfavorable moves in the stock.

Collared Stock

Collared stock, or ‘collars’, are similar in approach to a covered call. In this strategy, you should start with a covered call. But the difference is that you will not take a premium to reduce the cost of your positions. Instead, you’ll take that profit to buy a put option and use it as added downside protection. By buying the put option, you’ll get the right to sell your stock at the strike price. And the best part, despite anything that could happen, you’ll have the right to sell that stock at the strike price. Frankly, this put option is the best stop-loss you can buy.

This strategy is suitable after a large run-up in the stock. Also, when the investor assumes there is a notable downside. You can tune Collared stock to take the remaining risk out of the stock position. How much it will be, depends on the position of the call and put options strike prices relative to the current price.
For example, if you got $1.80 for the sale of 115 call option.

How much put to buy?

Let’s go further. If you have, let’s say the 110 put costs $2,75 and 105 put costs $1,15, you have a tradeoff. So, make it. The other solution is to buy the 110 strikes that will give you almost the full protection. Or you keep a bit risk on the position and purchase the 105 strikes. For the first solution, you’ll need more money, you’ll have to pay an extra amount of $0.95 for the protection. It can be a rocky path. Instead, buy the 105 strike puts. By entering this position, you’ll save $0.65 in cost reduction.

Can you see it? This strategy means to take off as much as a possible risk from stock you can. The point with tradeoff is to take upside reward with the most risk you take off.

In essence, it’s almost the same when you’re selling the stock. The potential risk is big, so the reasonable question is why shouldn’t you sell the stock instead? It’s simpler. Anyway, this strategy is broadly used by hedge funds to limit the market’s moving.

Short Put or Naked Short Put

Nothing indecent to see here. All you are performing is writing a put for the premium, or the credit from selling the put. It is alike as a covered call but without the stock.

When you sell the put, you have an obligation to buy shares from the counterparty at the strike price if they decide to execute the contract. You’ll sell a put when you suppose the stock price will go up or stay near to the current price. But, if the stock increases, you’ll keep all the money you got from the sale.

But there is another way also. You can use writing puts to be paid to wait for the price to pull back. And then enter the stock. In essence, you’re paid to take the risk of some other trader’s stock. Your hope is the stock will pull back and the option will be exercised by the owner of the stock. So you’ll take delivery of the shares.

This strategy is excellent while the markets are high. Well, what will happen if you don’t want that stock or the price suddenly drops? The premium will compensate for the drop. Same as with a covered call. If you try this with stock instead of the options, there will be no compensation.

With short put, you’ll have lost less than you can in stock trading.

Generally, short puts outperform covered calls in risk-reduction trade-offs but unfortunately not in all market conditions. There is a concept in options trading known as the “volatility smile”. It points out that markets are more terrifying than greedy. Remember, since a short put doesn’t have stock in the position, you’ll need to be very active to stay invested.

This is a kind of leverage, so you’ll have to use it very carefully. The beginner traders should approach short put trades with the knowledge that they could be forced to buy the stock at the strike price of the put they sold. It’s very reasonable to keep aside enough money to buy the stock if you are assigned.

Risk Reversal as low-risk options trading strategy

With options, the focus is on implied volatility. This means, when the market falls, implied volatility increases, and vice versa. The market becomes rougher when stocks decline and more pleasant when stocks grow.

A risk reversal copies buying stock. That means you’re selling a put and then using those profits to buy a call. But as a difference from the stocks, in this position, you’re taking advantage of the already mentioned volatility smile. It will allow you to spread out the exercise prices and take additional advantage of volatility differences.

This low-risk options trading strategy is a great method to employ for a big move up in stock. But, you’ll not be allowed to play in the zone between the put and call.

Put Spread

So far we mentioned the low-risk options trading strategy that trades upside for downside protection. But there are other low-risk strategies for options trading.
When you trade a position that has direction there is one obvious risk that won’t go away: the risk that you’re wrong in gauging what is the future direction of the stock. In options trading, you don’t need to trade a direction. You don’t have to determine if a stock will grow or decline. Instead, you can trade volatility and time decay. One of the lowest risk strategies is the calendar spread. The calendar spread is when you sell a near-term put and buy the same put but with the later expiry date.

For instance, you sell the March 100 put and buy the April 110 put. So, if we know the pricing is based on the future value of the stock, the more time the option lasts, it will lead to more value. That is the benefit of the calendar spread.

But why would you need to do this? Simply, to benefit from the time and volatility changes. This isn’t the most exciting strategy but in trading, less is more. In other words, less excitement means less risk.

How can you make money?

Easy! As you go closer to the expiry date of the first put contract, its value will decline every day more than the longer-dated put. But you’ll have to stay close to the current trading range. Meaning, take advantage of the time decay of a short put. This is the way to have a steady increase in profit as long as you stay in the range. Don’t wait for the expiration date. Wait until 15-25% of the maximum return. You’ll have a nice profit.

With these low-risk options trading strategies, you’ll have some of the tools needed to add to your portfolio. These strategies are commonly used for trading stocks but you can also buy calls and puts if you want to trade cryptocurrencies. In trading any market, it is very important to be equipped with the knowledge of how to take lower risks and maximize the profit.

More articles on this subject:

>>> Low-risk Options Trading Strategy

>>> Mistakes in Options Trading – How To Avoid Them?

>>> How Options Trading Make Money?

>>> Greeks In Trading Options As A Risk Measure

>>> What Is Options Trading Examples

>>> Trading Options – Understand the World of Options (Full tutorial)

>>> Short Call Option Strategy Explained

24th June 2020
Does Trading Strategy Really Work?

Your trading strategy must have a logic behind it. Without it, your strategy is useless and won’t work in any case.

By Guy Avtalyon

Does the trading strategy work? How can you know that? Developing a strategy is a lot of work. You might think that creating and developing a profitable trading strategy requires a lot of work. Yes, that is the truth. But you should never stay stick to the first version of your strategy, you have to develop and improve it all the time. In other words, it is permanent work. For the trading strategy to work, every trader will continue to work on it. So, the question: Does the trading strategy work is present all the time in your mind while executing it. Even if you have had a lot of tests, adjusted it numerous times, you will always ask this simple question because the profitable trading strategy has to make you money. Does the trading strategy work, it depends on how much it is suitable for all market conditions.

That means it is able to produce a profit. If you expect the mathematical accurate answer, forget it. To know the answer to the question: does the trading strategy work we’ll need a large sample size.

But, what is a sufficient size of it?

In trading, everything is based on probabilities which will become higher with the growing number of trades executed in profit. But why should anyone need a mathematical proof to know: does the trading strategy work? In trading, practice is crucial, no matter if it is with paper or real money.

And here is the catch! Who can afford thousands and thousands of trades before concluding that the same strategy doesn’t work? Also, you’ll need almost the same number of trades to test your strategy after any adjustment. And, what if you find at the end that it isn’t able to produce you a profit? So, an attempt to mathematically prove that some trading strategy works requires a lot of time, a large sample size, and a lot of hard work.

What you really need in order to find: does the trading strategy work, is a practical approach to this topic, not a mathematical one.

A practical way to to find the answer to the question: Does the trading strategy work

Since it is hard to have exact and absolute results, we’ll need a practical one. Okay, you can test your strategy on numerous virtual trades but you’ll have to be a programmer for that. So, how can we know that our strategy works and test it manually? But keep in mind, nothing is perfect in trading.

How to check if your strategy works?

Let’s assume you are a beginner. In such a case, just observe your trades as groups of, for example, 20. Before you start trading, write down all the rules that you will implement to all 20 trades. Okay, you are ready to enter the position. The next step is to add all your entered trades to your trading journal. After 20 trades, check your rules and find where you didn’t follow them. Based on trades where you did follow the rules, you could find does the trading strategy work.

First, you’ll figure out how your strategy fits the market. Did it match the market conditions during the given time frame? The crucial info you’ll need is how well did you use your strategy, was it adjusted for particular market conditions during this test?

When you find all these answers you might have an accurate picture.

Let’s assume that 15 from the group of 20 trades were successful, and you stayed with your rules, plan, and you recognize when the market conditions were beneficial for your strategy and when they were not. But, we’ll suppose that your 15 trades were all profitable.

Did you compare this group of trades and their main indicators, for example, Required Rate of Return (RRR), the average return per trade, win rate, to your backtest data? Well, it’s time to do that. Are there any differences? No? Nice, go further!

But if you find, in that comparison, some differences, you’ll have to find what was wrong. It could be that you made some errors in the trading process or you missed something in backtesting. Remember, literally anything may have a great influence on your strategy’s profitability.

When you find what’s going wrong, just adjust your strategy based on errors you made and trade another group of 20 trades, but follow the rules you set up. Now it’s time to compare the result of the first and second groups. You will know the result of your adjustments. If the strategy is doing well, trade another group of 20. After 100 trades or more, if you like or want, you’ll figure out: does the trading strategy work.

Use an out sample to find: Does the trading strategy work

We showed you how to do that above. Keep in mind that markets are changing all the time as well as our performance. So you’ll need to know how your adjustments influenced your trades. Did you want that? If your strategy still doesn’t work as you want, you have to consider why that is.

For example, if you lost 20% of your account, it’s time to step away and find what you are doing wrong. Maybe your stop orders are not set properly.

Trading means dealing with risk every day. It is very helpful if you have all data in your trading journal and the calculations of standard deviations and ratios. You can move forward based on that data. Consider that your sample size is still small, maybe you’ll need a bigger database, so try with a group of 30 or 40 trades.

Remember, evaluate your most recent group of trades as an out sample and don’t add it in the overall evaluation. Even if your most recent trade was a failure, don’t panic, stay calm, and calculate everything you can. If you find something strange, change it, if not, just move further.

How to optimize your strategy?

Basically, you have to estimate if your strategy is suitable for the particular market condition during the given time frame you are observing. Further, are you following your own trading rules or you are flexible about it. If you follow your rules, you’ll have to check out how your rules correspond to the market. Maybe you’ll need some adjustments if your strategy doesn’t work well. You have to figure out how your most recent group of trades matches to the trades executed before that. And if there is any exceptions you have to reveal why, so you have to stop trading until you find out why that happened.

Markets are changing and your strategy should be evolving according to them.

Optimizing a trading strategy means making small adjustments, small changes in strategy to increase the final result of its performance. Hence, optimizing a trading strategy is crucial for your overall success as a trader. Don’t forget that optimizing a strategy means to go over the whole process of testing, otherwise, you’ll not reduce the risk of unforeseen impacts. So, you’ll need to try and check, again and again all over the process. That’s the only method. You have to make small changes, to change the value of variables for a bit, and check and check. Try out various combinations in order to find the right one.

Trading is hard work. You’ll need to put in hours and efforts to become successful in trading. It isn’t a ticket to easy money!

Moreover, you’ll be faced with serious struggles. Trading will require your capital, your abilities, your trading method, technology, your knowledge, risk management, and many other things. More skills you have, more chances of success.

Does the perfect strategy exist?

Forget about finding the perfect trading strategy. Such a thing doesn’t exist. But remember that your strategy could be a good servant but a bad master. It depends on you and how often you adjust it to work for you. A trading strategy should regulate and route your trading activities. It has to work for you, not you for it. Keep this in mind when creating your trading strategy and make it robust enough.

Also, your strategy should be easy, clear, and simple. Review it often to assess how well it is doing, does it provide you the returns, how big, etc. If your trading strategy doesn’t work for you, don’t be ashamed to change it.

John Maynard Keynes said: “When the facts change, I change my mind.” Does the trading strategy work? Only you can know that.

15th May 2020
What Is Momentum Trading and How To Start?

Momentum trading is particularly successful in volatile markets. The main rule is “buy high and sell higher.”

To understand what is momentum trading you’ll need to know that this strategy is based on the recent strength of stock price. Traders that practice this trading strategy believe the price of an asset will continue to move in the same direction if there is enough force to push it higher.

Momentum trading is an aggressive approach to trading. You have to know that before even trying to fully understand what momentum trading is.

The simple answer to the question: What is momentum trading also can be: It is a simple buying and selling of stocks, for example, based on the recent strength of price trends. We mentioned the force behind the stock price, so let’s explain it more detailed.

When the stock goes up and as it reaches the higher price, more and more traders are interested to buy. Their interest is driving the stock price higher and higher. That is the so-called relation between demand and supply. As the number of stocks is the same, meaning the supply is the same, the contest among the traders will increase the stock price. And this price growth will continue with the increasing number of buying in the market. But at some point, some of them will start to evaluate if the stock is worth enough to be sold. If there are enough sellers of that stock, the momentum will change the direction and the stock will go down in price.

What is the momentum trading here?

Momentum trading occurs when traders open their positions after they notice there is a strong trend in stock price. They will close their positions when the trend begins to lose strength. Momentum traders don’t need to wait until the trend hits the top or bottom. Their focus is usually the middle range of the price move which presents the main action in the stock price. This range shows the strong buyers sentiment, everyone would like to buy such a stock that has an upward trend. So, what momentum traders do? They are starting to sell the stock at a higher price.

In other words, momentum traders will attempt to recognize how strong the trend is in a particular direction. Then, they will open their positions to take benefit of the predicted trend development while the stock price is low enough and close their positions when the trend begins to lose strength but the price is high enough to provide them a profit. Momentum traders intend to use the tendency of other traders to follow the majority and profit from that.

The principle behind momentum trading is “buy high, sell higher.” So momentum traders will keep winning players among bought stocks but they will sell the stocks that are not. The money earned will be used to buy more stocks that were doing well.

The essence of momentum trading is to sell the stocks that are dropping but not too much. Previously, the traders must have a confirmation that the change in stock price is real and that will continue in the direction. So the trend must be confirmed.

What is momentum trading else? It is an excellent strategy with great results in volatile markets where quick access is important. When it is done correctly, momentum trading could provide potentially large profits. This trading strategy requires an outstanding and quick process of decision making and that’s why this approach can provide traders more profits than some other strategy for the same time spent.

Risks of this trading strategy

Momentum trading is risky without a doubt and this can be one of the answers on the question of what is momentum trading. But if traders are careful and monitor the market and trends closely, they’ll be ready to buy and sell the stocks on time. It is very important to notice the main change in trend. If the traders miss them, they may suffer big losses. Entry points and exit points or profit targets are extremely important.

Momentum traders have to recognize the point when to enter and close their trades, the level where to exit the trade. It is also important to recognize the proper time when to take any action. For example, if the trader closes the declining stock sales in time such will end up with the profit. But if the trader fails to close the sale quickly such a trader will end up in great losses caused by the stock’s decline in value.

It is very important to notice the stock’s sharp drop in price, sell the stock on time, and avoid a dangerous influence on capital involved in the trade. So, the timing is extremely important in momentum trading. The trader has to be absolutely sure that stock is starting to decline and enter the position promptly to sell it. Otherwise, it can be almost impossible to sell it.

And to answer the question of what is momentum trading. Momentum trading is set to be a remarkably prosperous strategy but has to be performed perfectly.

How to start momentum trading?

Identify the stock you are interested in, choose your momentum trading strategy, but first test it on some demo account. But keep in mind several things.

As we mentioned above, the volume is crucial to momentum traders, because they have to enter and exit positions promptly. That means there are enough sellers and buyers in the market and the good volume shows the stock market is liquid. Volume is the number of stocks traded in the market, it isn’t the number of all transactions.

Momentum traders seek volatility because the high volatility provides big swings in stock prices. That is an advantage for momentum traders, these short-term increases and decreases in stock’s value give the traders a chance to profit. Of course, only if they have a good risk management strategy as protection. That means they have to set stop-loss and limit orders.

As we said, time is important. This strategy is adjusted for short-term market movements, but if the trend keeps its strength longer this strategy is useful for position trading too.

Momentum trading in the stock markets

To be successful in momentum trading in stocks you’ll have to follow some rules. You’ll need the protection against big losses. So, you’ll need to trail the stop-loss, that will provide you to ride the trend. Set your rules for classifying the stocks to know which stocks to buy. Buy stocks on the uptrend market.

For example, if some stock reaches a 50-week high you should go long. If there are many stocks of that kind, make a selection of best 15 or 20 with the biggest raise during the last 50 weeks. Set a trailing stop-loss at a minimum of 20%. Never trade more than 20 stocks at the same time and distribute 5% of capital to each of them. The saying “never put all eggs in the one basket” is relevant to the momentum trading also.

Momentum traders are focused on price action and rely on technical analysis and indicators because they need to decide when to enter and exit each trade, as we described above. Favorite momentum indicators among traders are RSI (the relative strength index), the stochastic oscillator, moving average. Of course, you can use any other technical indicator but these are the most popular.

Bottom line

To be able to understand what is momentum trading you’ll need to have severe risk management. The stock market is volatile and momentum traders need to notice price fluctuations and price pitfalls in the market.
Don’t neglect the basic elements that could lead to price changes. Sometimes it is better not to think about the next big rally. Think about profit. It might come even if there is no big rally.
Carefully pick the stocks to trade, set stop-loss levels, place your entry at the right time, systematically monitor the market to notice possible changes, plan, and set your exits.
Use protective rules for every trade. Momentum traders will set stop losses to protect their trades from unexpected price reversals. There is no other way to be a successful momentum trader. We hope you have a more clear picture of what is momentum trading.

12th May 2020
Trading Mistakes and How to Avoid Them

If you have losing trades it is possible you have too many trading mistakes. Recognizing mistakes is half of the battle. The other half is how to avoid them.

Trading mistakes are common both for traders and investors, for the novice and experienced traders. Even though traders and investors practice different styles of trading, they often make the same trading mistakes. Some of the mistakes are more costly for investors, some for traders. For both kinds of market participants, it is essential to understand these common trading mistakes and avoid them. Think about bad trades as a process of learning and after you collect a significant number of them you’ll be more experienced and able to perform better trades. But this process can be shorter if you have an upfront understanding of where trading mistakes could arise.

That could give you a chance to react correctly and quickly enough to protect your investment portfolio.

Here are some trading mistakes that happen to both experienced and novice traders. These suggestions could help you to recognize them and give you a chance to avoid or correct them. So you should be able to gather the profits!

Trading mistakes that traders shouldn’t do when trading

Never risk a huge amount of your capital or going all-in. We all have a great expectation to earn a huge amount of money but one of the trading mistakes is putting all capital into a single trade and expect that could provide you great profits. How is that possible if every single trader, when asked, knows about the 1% rule. That means you should never put more than 1% of your capital into one trade. This is one of the common trading mistakes because traders constantly try to gain it all back. Mostly without a risk management trading plan. But even if you have a trading plan, sometimes you’ll be pushed to ignore it. You could be motivated to take a large trade which usually you wouldn’t. Don’t do that, try to resist. Stay stick to your risk management trading plan. The temptation can be a very bad companion in stock trading.

Even if you think you are ready for a big portion in a single trade. Trust us, you don’t want to jump into the deep end. Especially if you are not skilled enough. Going all-in may cause unpredictable damages, financial and emotional, so great that you may decide to give up the stock trading forever.

The much better approach is to trade gradually at regular intervals and slowly increasing the amount per trade. In this kind of approach, you have two benefits: you won’t put all investment capital at risk and you’ll remove emotions when deciding when to buy a stock.

Not having a trading plan is a great mistake in trading stocks

Among trading mistakes, this particular is maybe the most dangerous. If you don’t have a trading plan how will you know when to enter the trade or exit the trade. Skilled traders get into a trade with an outlined plan. They know their precise entry and exit points, how much capital to invest in the single trade, and what is the highest loss they want to take.

Novice traders usually don’t have a trading plan before they start trading. Even if they have a trading plan, beginners could be more apt to turn out of the plan and take more risks and reverse the course totally.

For example, they enter the trade with the belief that the stock price will rise shortly after they enter the position. That isn’t going to happen! But this fact is known to experienced traders, beginners don’t know that. And what happens the next is the trade is going against them. But most of them will not exit the position, they will hold in the hope that the price will go up. And the price continues to fall more and more but they don’t want to sell the stock, they don’t want to take the loss and end up losing everything. That is one of the most dangerous trading mistakes.

Further, even if they found a great entry point and the price starts to rise. Honestly, it could be a matter of luck, not knowledge. What do beginners do? They become greedy. Instead of selling stock and taking a profit, they hold the position. Very soon, the trade turns against them, and a winning trade shifts into a losing trade.

Shorting stocks too early

If you short the stock too early it is more likely you’ll be destroyed on your shorts. Everything that flew always landed. This is especially true of stock trading and pumps and dumps.

For example, you notice a stock in the early stage of a pump. You are happy to buy and drive along as it increases. But at some point, it starts to drop, and you may profit by selling short. But when is that moment? When you have to go short? The timing is extremely important. What if you sell too soon? How to recognize that exact moment for short selling? First, you have to find the top on the stock. That means you have to recognize the resistance level. That is the point where buyers are leaving, but also the point where the sellers appear and begin to take over the stock.

Short selling is dangerous anyway and only experienced trades should use it. If you practice this strategy or want to, be careful. Without proper knowledge and experience, you’ll jump into one of the biggest trading mistakes.

Use stop-loss orders to avoid trading mistakes

Cutting losses is a very serious issue. If you don’t cut your losses quickly you could lose everything. This mistake apparently takes most of the money. Avoiding to admit that we’re sometimes wrong, we are actually admitting we’re human beings. Nothing is wrong with that. People are doing that all the time. Sometimes it can be good. But not in trading stocks.

The main problem with trading and you cannot find many people that would like to admit that, is that there is no possibility to be correct on your trades 100%. The best traders are correct under 80%. How do they manage to not blow up their accounts? Simply, they know when they are wrong, they recognize that and admit that. When wrong trade occurs just get out fast. Why will you wait? To make more losses? No one would like that. Just admit you are wrong and exit the trade while you still have a chance to reduce losses.

But you must decide about your risk before you enter a trade. You have to know your risk to reward ratio and how much you are comfortable to risk.

When you identify what you’re ready to risk, enter the trade. But that is not the end.

Set a stop-loss order

You have to set the stop loss. For some traders, it sounds unnatural to enter the winning trade and promptly set stop-loss order. We have one question for them. Is it natural to lose all capital invested? And, yes, there is a possibility to lose everything without setting a stop loss. In this way, you’ll avoid making huge losses to your account.

Never neglect stop-loss orders. That will prevent you from extreme losses and lock in profit when you have winners. You have to set a stop loss for every single trade.

You might think you don’t need this order while you are sitting in front of your computer all the time. But you don’t have that single one trade to monitor, sooner or later you’ll have more of them. It’s almost impossible to monitor several trades at the same time. Changes are speedy and it could happen that you don’t notice the stock is losing support. In that situation, everyone would like to get out as fast as possible. The stock price could fall a lot faster than you are able to set your sell order in. And what did happen? All your profits are wiped in a second. By setting stop-loss orders at the moment when the trade is filled.

Bottom line

Trading stocks is not an easy job. It takes discipline, time, and knowledge. Some traders can’t handle it and gave up. Also, there is one thing you must know before entering this marvelous world, the most important part of trading is preparation to execute it.

You cannot find a lot of people out there to help you figure out what trading mistakes to avoid. We pointed several but there is much more. To be prepared to avoid them, you have to learn and not be greedy.

As we said, trading isn’t easy but can be very profitable if performed properly. It’s okay to be wrong from time to time, but if you are wrong all the time you’ll never become a successful trader. Just admit your trading mistakes, examine what went wrong, and continue with success. While trading, your emotions must be under control. Okay, some level of fear is favorable, it can protect you from meaningless and harmful moves. But you have to be honest with yourselves and admit when you made mistakes. To remember them better, write it down in the trading journal. That will make things easier in the future.

5th May 2020
The Importance Of A Trading Journal

If you want to become a successful trader you will do what is obvious, you’ll start keeping a trading journal. That will give you a lot of benefits.

The importance of a trading journal isn’t arguable. A trading journal is helpful for every trader to track trades. Using a trading journal is one of the essential components for trading success. Even the most successful traders understand the importance of a trading journal and use it all the time.

But still, some traders don’t understand the importance of the trading journal and use it inefficiently. The reason for doing so is quite hard to understand because using a trading journal is a great tool. Without it, you will not be able to execute your trades with higher efficiency. The importance of a trading journal is obvious if you know what kind of important data it can provide you. It could show you the info about what were the market conditions and you went through them, where you were panicked and wrong or had successful trades and under which conditions. Another importance of using a trading journal is that it can give you a clue for your future trading strategy since you have recorded your prior strategies.

Keeping a trading journal is an exceptional strategy to improve performance and grow confidence in trading. Success in trading doesn’t matter if it is stock, options, forex trading demands a high level of planning and discipline. If you want to be successful in trading, you’ll need to go through a full learning process. And here we come to the importance of a trading journal, one of the best tools that will guide you and help to optimize your trading system and can drive you towards profitable trades.

What is a trading journal?

As we said, a trading journal is one of the most powerful tools for trade management. It is the place where you have recorded all your trades and you can always check for better output and for future trades. By using a journal you can track development as a trader but also examine mistakes you made when you enter or exit your trades. Without it, you cannot act. It is your best base for better future executions.

The importance of a trading journal is that you have all data records ordered by the date with all trades that you ever take. You’ll have all entries, meaning every single trade ever taken. So, you’ll have a prompt overview of all trades you made, every entry and exit prices, the prices’ direction, the size of all your positions, all trade results. Of course, you can add to your trading journal all data you want and find they can be useful for your trading success.

Why keep a trading journal?

The same as it is important to have a trading strategy, one or several of them, risk management, it is also important to keep a trading journal as a part of your trading plan.

It is important to keep a quantifiable record of your trading performance and learn from past winnings and losers. However, past performance cannot predict future performance, but you can use a journal to learn from your trading history, to recognize the emotional actions, why did you or the price go against your strategy. So, your trading journal should include all your profitable trades, also unprofitable, market records, the reasons behind all your buying or selling the stock, and many other details.

At first glance, it looks very complicated and you may think it’s better to give up before even starting, but when you start it and recognize how beneficial it can be to keep a trading journal, you’ll stick with it throughout all your career.

What are the benefits?

Your trading journal is the most important statistic of your trades. It keeps tracking your progress and it is by far the best way to estimate how successful you are. By keeping a trading journal you’ll have valuable feedback on your performances but also, you’ll have the patterns that will provide you important and accurate information about what you did well and what you have to change.

As we mentioned above, it may seem like a complex work but in essence, a trading journal is a simple diary where you have to write down all your trades, the reasons behind them, and how it ended up.

We say the end is very important, we say it deliberately.

If you plan to become a successful trader, all ends are important and should find their places in your trading journal. Never add only the winning trades or ignore the losing ones. You’ll need a valuable tool that will provide you accurate feedback into your trading method. That’s the main goal of keeping a trading journal.

What traders do wrongly?

There are several major mistakes (more about “option trading” mistakes in this article) in keeping a trading journal. Some traders will just add the stocks they trade but forget to write down how the trade ended, did they have the winning or losing trades. That is a common mistake that leads to keeping a journal incorrectly. You have to know whether you executed your trades in profits or losses and you’ll need that information documented later to recognize the patterns.

Add to your journal what were your reasons before entry, where you placed the stop-loss, where was your target profit. Also, it is important to add how much risk you planned to take and write it down in money. The next step is to follow your own rules, right? That will show how you manage your trades.

But let us explain why it is so important to add market conditions to your journal. If you don’t, there will be a great possibility to continue trading out the market context. Moreover, you’ll not be able to seek new approaches and ideas of trading.

More detailed explanation

If you have data about market conditions added to your journal you’ll be able to recognize the markets with a high possibility for more aggressive trades. In case you aren’t that kind of trader, you’ll just stay away because you’ll know when not to be in the market. On the other hand, if you like that kind of trade you’ll be ready to take a risk.

Additionally, the trading journal will give you a great chance to monitor movements and risks, to recognize the strength and weaknesses in your portfolio. It will give a clear indication which stocks or other assets you trade well and which you don’t manage well. If you ignore this information you’ll not earn the money. It is more likely you’ll have consistent losses. What really you would like in such a case is to get your money back.

There is a difference between a bad trade and a bad stock and you have to realize that. Maybe the stock is quite good but you don’t trade it well.

The journal will show you which stocks you have to focus on.

What things to add to your trading journal?

The following are basics.

Add the stock price action before you enter the trade. It can be a one or two hours time frame. That will be the context in which you’ll open the position. Further, include a text note of your starting time to know if you enter the trade too early or too late. Also, why maybe you did miss some signals.

One thing is also important and it is smart to add it. Add, it can be a kind of reminder, what are the market circumstances that could force you to stay away from trading or you missed the trade. When such a circumstance occurs, write it. Write down that you didn’t trade because of the news, for example.

Write a note about the trends you saw. If you made a mistake, write it also. Do the same if you miss a trade or how many trades you made, make a note of it. Note how many winning or losing trades you had, calculate expressed in money how much you earned and loss, and write down the net result. But this method may have some disadvantages so it could be better if you, instead of money to use points for the futures, or cents for stocks, as well as pips for forex trades.

Bottom line

Keeping a trading journal makes a difference between amateur traders and professionals. Professionals understand the importance of a trading journal. You can count on a lot of benefits when you start keeping your trading journal. First of all, your whole comprehension of trading will be changed and you’ll get a better direction, of course. Moreover, you’ll be able to make progress from the very first day. You will have confidence and trust in your strategy and your skills when your journal backs you up with the statistics that verify that your strategy works.

These are only a few benefits of a trading journal. If you want to become a successful trader just use this number one tool for professional traders. That will improve your trading.

26th April 2020
Stock Market Bottom And How To Recognize It

Nobody can with certainty predict a stock market bottom. Still, it’s worth at least thinking about different entry points to let your money work for you.

By Guy Avtalyon

The questions for the past several weeks mainly were all about the stock market bottom. Did the stock market hit the bottom? Will the stock prices stop dropping? Have stocks reached support levels? When will prices stop falling?

Stock traders have so many questions these days and weeks. But do they really know where to look?

Maybe one of the most terrifying jobs related to investing is about the stock market bottom and how to recognize it. The idea to predict when a given stock will hit the bottom is old as much as investing and trading. The point is to recognize the point where the stock will no longer drop. The rule of thumb is: buy low, sell high. The problem arises when we have some unpredictable events in the market such as this one, coronavirus pandemic. That has an influence on the global economy, almost all economic and political events, and decisions. So, with a high level of certainty, we can say finding the stock market bottom can be a discouraging job.

Well, this kind of question traders ask almost every day but are they looking in the right place to find the answer? For example, investors are looking at Dow Jones. Is it the right place? We are afraid that the value of DJIA isn’t able to alarm you when the stock market hits the bottom. Okay, it will tell you but after it happened.

So what to do?

How to recognize the stock market bottom?

If you want to find it, you’ll need some indicators. Indicators can tell you when is the stock market going to hit a bottom but also when it is going to recover. By using indicators you’ll not miss the beginning of the wave. When buying a stock you want to do so at the lowest possible price but you wouldn’t like to hold falling stocks. You would like them to start rising after you bought them, right? That’s why it is so important to recognize the stock market bottom. The point where the stock can find support.

That knowledge can give you huge profits and prevent huge losses. So, how can we know with certainty that a stock has touched a low point? To be honest, no one can do that with 100% certainty and consistency, but traders and investors have some tools, fundamental and technical trends, and indicators. They arise in stocks when they are about to tap the bottom.

The indicators of stock market bottoms

Some indicators can help us determine when the stock market is going to form a bottom. What we really need to have are indicators of the health of a global economy and what the main participants in the market are doing with their money. But keep in mind, there is no such thing as a magic indicator to identify a stock market bottom. We have to look at several indicators to have an idea of the economy’s and stock market’s health.

Second, we have to look at history because it will tell us that the average bear market persists about 17 months. Also, it corrects around 35% from the maximum. But keep in mind that you cannot find the two bear markets alike 100%. All we can do is to suppose that the next will be similar.

Further, we have to understand the valuation. For example, the S&P 500 has a P/E ratio and earnings. The P/E ratio will move up and down depending on the market period. It will be up when we have good earnings growth, all ratios including the P/E ratio will go up. But when the circumstances are changed, with rising pessimism the valuation is likely to go down.

For example, when the S&P Index was above 2.500 the P/E ratio was at 19.

Also, the higher the VIX is, the chances for the stock market to hit the bottom are growing. These first two days in April this year, VIX traded between 54 and 57. If we take a look at historical data we can see that in 2008, the VIX was somewhere between 70 and 95. During the March this year, VIX traded over 75.

Other indicators of the stock market bottom

The stock market fell over 25% in 3 weeks. This is the sharpest drop in history. The biggest decline occurred on March 12th, the biggest since the market crash in 1987. Many investors thought that a stock market hit a bottom.

If you want to recognize when the stock market bottom is, check out your emotions. Did you feel fear at that time? If yes, you were one of the millions with the same emotion. Fear was so obvious in the middle of March. To be honest, almost all were panicked.

But we have to try to be reasonable. Just take a look at the charts and the technical levels for those days. Can you notice the major pivot? Do you notice a bottoming tail and a huge volume?

Okay! A major pivot, bottoming tail, and a huge volume on the same day and combined with a market 3-weeks decline of 25%, are indicators there was some at least short-term bottom.

What to do when the stock market is near the bottom?

The most intelligent investors started to buy those days. Small chunks, nothing big. Smart investors are doing such a thing to accumulate their full positions. The point is to buy 25% or 30% even 50% of the total position. That will keep your potential stress down and provide you an all in all a better average. But remember, don’t buy some small-cap, go for the brands.

Where is the market bottom now?

That is the most frequently asked question since coronavirus appeared.

Market experts like to say that it’s impossible to time the market. Well, it isn’t the truth. If we can see the market tops, why shouldn’t we see the market bottoms? Institutional investors know that. Follow what they are doing. Their actions could be the key bottoming signal. Follow-through has been noticed at almost every stock market bottom. This signal is extremely important because it can provide you profits when the early stages of a new market uptrend is confirmed.

The quest for a stock market bottom

This signal works quite simply. When there is a sustained stock market downturn, the first rising day from the index low is most important. That could be the beginning of a rally attempt. No matter which index you are using S&P 500, Dow Jones or Nasdaq.

According to some experts, the gain expressed in percentages isn’t important at this point. Also, don’t pay attention to the trading volume. What you have to look at is a down session and the moment when the index bounces after a great drop and closes close to session highs. Some experts deem that closing in the top half of the day’s trading range is adequate also.

Further, find a bigger percentage gain in higher volume than the prior session several days in the rally attempt. This time period is making it possible for short covering to resolve and for a rally attempt to gain ground. The rally will be halted in place only if the index reaches a new low.

How will the market react after the pandemic?

It is good if the market supports the new buyings, but if it doesn’t, just be patient. Sometimes, breakouts are visible on the charts after a few weeks. This market crash caused by the coronavirus outbreak has a large supply of stocks making the new base. But a lot of them have yet to bottom.

If an index suffers a decline in higher volume shortly after the follow-through day, the signal will fail in most cases. If close below the low of the follow-through day, it is almost the same. It is more the sign to start selling the stocks you bought recently.

These signals don’t mean you should rashly jump into the market since they tend to fail after indexes have dropped clearly in a short time. That happened with the stock market correction in February. The more suitable is to buy a few stocks, maybe one or two, and test how they will work. If there is a real uptrend your stocks will rise.

Every investor wants to know when trends are going to make a significant change. Will they reach tops or bottoms. The truth is no one knows that for sure. Only the big volume spikes, and staying stick to the chosen sector, will give you some clue if the stock has reached the lowest level from which it will not decline more. We pointed just one of the numerous scenarios. There are many others.

3rd April 2020
How to Trade Stocks and Make Money?

Everyone would like to know how to successfully trade stocks but only a few know how to do that. Here are some suggestions.

There are not many people who know how to trade stocks and make money. Statistics confirm this. According to stats, only 5% of traders are successful. That means 95% of traders fail. Surprisingly, some stats show 80% of traders leave trading during their first two years. Moreover, almost half of all traders quit during the first month of trading. The other problem is that traders sell winners in a bigger percentage than losers.
Profitable traders represent a tiny part of all traders with just 1.6% in the average year. Nevertheless, they are very active, the estimate is that they are accounting for 12% of all trading activities per day.

Stock traders’ problems

Maybe the biggest problem in the stock market is that traders don’t learn how to trade stocks and make money. They are gambling, to put it simply. Even when they are using some demo accounts or following elite traders, they use it to set up their trades automatically without a meaningful process or plan. We found an interesting thing, traders and investors usually overweight stocks in the industry in which they are working. That’s smart. That is the industry they know well, the companies are known to them too, so the probability of successful trades might enhance. But there can be some drawbacks too. The emotional approach to trade is one of them. Simply said, these traders may act as cheerleaders. That isn’t smart trading. Even if they have profitable trades, the percentage of such trades is small. Otherwise, there would be more efficient traders in the stock market.

Knowing these stats it’s understandable why traders fail. The trading decisions are not based on research or proven trading methods. They are based on emotions. Instead of learning how to trade stocks and make money, many traders view trading as a kind of game. Don’t hope to make millions with such an approach. It is more likely you will lose your shirt. Trading isn’t a game. On the contrary, it is a profession for which you’ll need skills, knowledge and continual education and development. It isn’t easy and no one should tell you it is. Hence, be careful of your trading decisions.

How professional traders know how to trade stocks and make money?

You might be questioning what professional traders know but you don’t. We are going to explain to you how to trade stocks and make money so you could act like a pro. It isn’t rocket science, actually, it is quite simple but we’ll need your full attention.

First of all, don’t think that becoming an elite trader is something you cannot achieve. You are just a few steps away from being that. All you need to unveil how to trade stocks and make money is just around the corner.

So, let’s start!

Successful traders usually don’t have any insider information that is unavailable to you. You can gather them also but the real question is why should you do that. In fact, all you need to have trading success is a small adjustment in how you think about trading. In simple words, it is all about your mindset. To become a successful trader you MUST change some of your trading practices if you want to know how to trade stocks and make money, of course.

There is no secret recipe on how to trade stocks and make money

Beginners in trading usually are looking for a secret and instant way to success. If you are not one of them, you probably don’t enjoy trading. It is possible you are looking for some tools that will guarantee the profit. Well, it isn’t wrong. There are so many tools out there. Many of them can make your life easier. But you have to love the trading process, even the charts reading and finding patterns. Yes, that isn’t the most exciting part of trading, some may say. But try to look at that from the other point of view. For example, finding just one good, steady, price pattern might enhance your trade and can be beneficial for a long time, maybe for your lifetime.

But let’s stay for a while on the subject of the joy of trading. The point is not to have fun (although you might have fun) but to understand what you are doing while trading and be ready to love it. There is no need to be an adrenaline addict but some dose of willingness to have excitement is necessary still. You have to understand the whole process, from the psychological perspectives, chart reading, to money management. And you have to love it. Otherwise, you will never succeed to become a really profitable trader. In other words, you need passion, knowledge, and tools.

The importance of tools in trading

When you start trading the stock market, you have to make three decisions: buy, sell, stay on the position. For that you need information. You have to know the stock historical performances. It is important to recognize the patterns. And that is exactly what one of the best books is giving to you. Let us introduce and recommend this particular one, the book The Two Formula: The Best Single Trading Pattern I Have Ever Used. This book doesn’t give you only theoretical knowledge. It is based on the personal experience of the author. That is the value per se.

What will you find in the book The Two Formula: The Best Single Trading Pattern I Have Ever Used?

According to the author, Michael Swanson, the first time he used this trading pattern was in 1999. And how good this price pattern shows the fact he is using it for even more than 20 years. He reveals that just one single price pattern is quite enough for successful trading whatever you want stocks, funds, futures, commodities. Basically, you can use this price pattern for anything that you can draft on the technical charts. We have been reading a lot of books about trading. Also, we examined a lot of patterns but this particular one is extremely interesting. This trading strategy is completely unique.

Few words about trading strategies

Essentially, a trading strategy is a method of buying and selling in the stock markets or some other markets. The trading strategy is based on rules that deem to end up with success in trading and in profit. So, most traders are guessing and trying to notice the bottom and the level where the price starts to go up in order to buy an asset in the hope it will rise further. The point is they are often wrong. Go back to the beginning of this article and you’ll see the stats. What do the majority of traders do? They are hunting price movement. But it very often turns into chaos. Why is that? They are not trading, instead, they are gambling, they place trades without a meaningful process.

When they see how big mistakes they have, traders use charts to figure out what is wrong and try to fix it. Sometimes they are spending hours, days even weeks, staring at the charts to predict how the price will go in the future by using technical indicators, a lot of them. And they are confused more and more. These complicated images can fry their brain but their trades will not become more successful.

The simplicity of The Two Formula pattern

For any trader, the simplicity of the pattern is extremely important. If you have too many indicators added to the chart you will have a blurred picture. The essence of profitable trading is to have a steady plan, something that really works when setting the position. You must have confidence in what you are doing and you have to know how your trade will end up. This “Two Fold Formula” book can help to achieve all of that.

Where is the catch?

This book shows how with a one price pattern setup you can make a profit while trading. Basically, it is a simple strategy and that’s why it is an effective one. Easy to understand, easy to use, without misunderstanding. Everything is explained clearly and smoothly and, what is most important, based on personal experience and proven.

Some traders have to lose, but you would have a chance to make a profit with this method. Any trade has only two ends: loss or profit. Why shouldn’t you profit? This may help you to trade like a pro.

Bottom line

People are afraid of the risk, but these two formula pattern seems to be using some good indicators and a more “tuned” strategy.

Pro tip: use it with our preferred trading platform virtual trading system to see if it’s working before trying on real funds (68% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you can afford to take the high risk of losing your money)

17th March 2020
The Stock Market prediction Is Possible or Not?

Everyone would like to know everything about this

By Guy Avtalyon

Stock market prediction is the intention since the beginning of the stock market. The reason is clear. Every single participant in the stock market aims to gain huge or decent returns and to avoid losses. Sounds logical, indeed. In early days traders and investors were just guessing, to say it simply. Well, frankly, not just guessing. There were some estimations, judgments, listening to the rumors, asking. But today, traders and investors may employ different tools, machine learnings, and AIs to help them in stock market predictions.

Is the stock market prediction possible or not?

We already learn that past performances can’t show future trends. But is this truth 100%?

Of course not.

Watching past performances can help you with a high level of certainty to predict how some stock will act in the future. This is very important because based on that data you will determine and decide what to do with some stocks. Would you buy or sell, would you stay on position or leave.

The modern stock market prediction is often based on machine learnings and AI technologies varying from very simple to complex ones. Those stock market prediction tools or techniques, whatever would you like to call them may help you a lot to secure your investments. Even the simplest can give you an insight into the future stock market trends.

Using robust algorithms has benefits, of course. But not every trader or investor can afford them. Some are very expensive and the result is very often almost the same if you use the simple version or some simple tool.

The crucial thing about stock market prediction is to have quite enough historical data to be able to make a conclusion, to have a basic sense of some stock’s nature.

How to predict the stock market movements?

The relationship between supply and demand is what dictates the stock price. And this works very simply. If there is in the market more sellers, that means the supply is greater than demand, so the price will decrease. And vice versa. That is the easy part of the stock market. Things become more complicated when you try to understand why some investors like one stock more than the other. But that is another question. We want to know is the stock market prediction possible or not.

The algos, tools, learning machines deliver their predictions based on historical data. This means that all of them show the prior values of some stock and based on that give the future estimation of stock price action.

And that is exactly what you need as an investor. To get some info with the highest level of possibility on how some stock will perform in the future. To have that kind of info you don’t need to spend a fortune. Some simple tools may benefit you too. Such a tool must have historical data about prior performances, for some limited time, for example during one year. Based on that info you will be able to check your trading or investing strategy. And that is crucial. The possibility to check your strategy on your own and not to put all in the “hands” of some algorithm, because we want to be honest with you, algos can make fails. Algos, as like your trading strategy, depends on inputs that some other implemented in it. To say simpler, it is based on other people’s knowledge about the stock market prediction and investor expectations.

Le’s check one example. Let’s say you have a strategy and you want to check how it works on a particular stock.

How efficient your strategy is?

If it shows your strategy isn’t good you can easily change the strategy or test it on some other stock. Moreover, the possibility to test different strategies on numerous stocks is extremely important when it comes to choosing the stock to invest in or strategy to employ. What is the main point of trading? To gain a nice return. And how to provide that? You have to find the best possible to take a profit point and stop-loss point.

Based on the info you can obtain from such a tool you can easily decide about your future trading.

Very simple and very helpful, don’t you think?

What Traders-Paradise wants to say is just stay tuned.

1st September 2019
Short Selling For Profit

What to do with stocks when the price starts to decline? Bet that a stock will fall more.

By Guy Avtalyon

Short selling for profit is a trading strategy that attempts to profit from an expected decrease in the price of a security. Basically, a short-seller wants to sell at a higher price and buy at lower.

How does short selling for profit work?

Let’s you are a trader and you have some information that some stock will decrease in value by the expiration date. Ofc, you don’t hold that stock but you can borrow it from a broker. For example, you borrow 100 stocks at $10 market price. And you open the position, meaning you want to sell them at market price by their expiration date. And you succeed. Then you close your short position and sell your borrowed stocks for $1,000. But before you give back that 100 stocks to your broker you are betting that their price will decrease in value before the expiration day. That happens. Now, you are buying these stocks at a lower price, it is called covering the short position.

Let’s say, the price of your borrowed stocks declines at $6 each.

You sold them at $1,000, bought them at $600. Return 100 stocks to the broker and you pocket $400.

(100x$10) – (100x$6) = $400

The risk in this kind of trading is literally unlimited because the price may rise and rise to infinity.

But, the profit can be huge, also. The previous example showed a short-selling for profit. Well, by using short selling you may gain loss too.

Example of making loss while using short selling.

The vice versa case is when stock price increase in value during the time while you are holding them.

Let’s say their market price rose at $14 each and you are holding 1oo stocks. The equitation will be

$1,000 – $1,400 = – $400

You borrowed those stocks at a $10 market price. But despite your expectations, the price increased which means you made a wrong bet. But you have an obligation to return those to the broker, hence you have to buy them back at that higher price. In this transaction, your loss is $400.

Short selling for profit is a method for traders to benefit from a drop in a stock’s price.

Short selling is only possible by borrowing stocks. The problem is they are not always available because when they are you may be faced with a crowd of other traders that already massively trade them.

Is short selling for profit risky?

The short-selling for profit can be risky and questionable. When a huge number of traders choose to short some stocks, their actions will make a great influence on the stock price. With such big traders’ interest, the price will decline sharply. That is not a good situation for companies. Their market value decreases. Sometimes the markets forbid short-selling, especially during the economic crisis.

As I said, short selling is risky for plenty of reasons. You can make a great loss if the stock price increases instead to decrease.

The other reason is that the sharp increase in selected stock may cause traders to cover the position all at once. Moreover, short-covering usually force the price to go up. Then you have a situation that more and more short-sellers are covering their positions and such stock is grasped in a so-called short squeeze. So, like a chain of unfortunate events, right?

The main purpose of short selling for profit is when you borrow the stocks from the broker to sell them instantly and buy them back at a lower price. And return them to the broker. When the whole process is finished you should profit from the difference in stock price.

Risks of short selling

Short selling involves a magnified risk. When you buy a stock you can lose only the money that you have invested. For example, if you bought one share at $300, the maximum you could lose is $300. Stocks can fall to $0 and that is the maximum, there is no stock that may fall below zero. The maximum in your potential loss will stop at your initial capital invested.
In short selling, you can potentially lose an infinite amount of money. Stock can increase its value for an infinite time to an inconstant price. So, you’ll have an infinite loss.
For example, let’s say you enter a short-selling at $200, and suddenly the stock price increases by 300% to $800. You’re obliged to buy the stock back and return them at $800, essentially losing 400% of your capital. actually, you are in incredible debt.

Just be careful when you bet against stock price.

16th August 2019
Shorting Stock – Explanation

Shorting a stock looks very simple. But, this isn’t a strategy for beginners.

By Guy Avtalyon

Shorting a stock is when a trader borrows stocks and quickly sells them. She or he does that in the hope that can buy them back later at a lower price and return them to the broker or lender. Of course, the trader pockets the difference in the stock price. Shorting is riskier than simply buying stocks. A trader that practice shorting is taking a short position, while investors that are buying and holding stocks have so-called a long position.

In other words, when some trader starts short selling, he or she borrows stocks from an existing stockholder through the brokerage. Than sells borrowed shares at the current market price and takes the cash.

What is shorting stocks?

Generally speaking, when you invest in stocks, you expect to profit from a company’s great times and increasing profits.

But this is a whole different type of traders, called shorts. They do just the contrary. They search the Internet for news about car industry recalls, for example, and look for ways to cash when the stock of such a company is falling.

It’s possible to make money when prices are going down. Of course, if you are willing to accept the risks which are big. One of the strategies to profit on a downward-trending stock is selling short. The hope behind shorting a stock is that its price will decrease or the company will go bankrupt. Of course, it can lead to total ruin for the stock owners.

Shorting a stock means you are profiting if the stock price drops inside the timeframe from your entering the deal and turning back the stock. But if stock price increases, you’ll take a loss. You can short almost every asset, stocks, ETFs, and REITs, but never mutual funds.

What short-seller do?

The short seller is a trader who is buying the stock back but at a much lower price. However, the short seller must promise to return the borrowed stock at some period in the future. Otherwise, the true owner or broker will never borrow the trader a stock.
Borrowed shares have no dividends until the short seller turns them back. Even more, he has to compensate for missing payments to the lender from his own pocket. So, when short-selling it is very important to have accurate information.

When you want to close your short position, you have the obligation to buy the same number of shares at the current price and return them to the lender. Your profit or your loss comes from the difference between the price you sold the stock and the price you bought them for.
The stock for short selling can come from the broker’s inventory, a client of the firm, or from another brokerage company. When the shares are sold, the profits are added to your account.

How to shorting a stock

That involves some important steps. One of them is a short-term strategy.

Selling short is essentially created for a quick profit in stocks that you expect to decrease in value.
The main risk of shorting a stock is a possibility for the price to increase, and as a result, you’ll have a losing trade and losses. The possible stock price valuing is theoretically unlimited. Therefore, you are maybe exposed to great losses in a short position.
Also, shorting stocks involves margin. Hence, a short-seller can be subject to a margin call if the stock price moves up. A margin call requires a short seller to deposit additional money into the account to fill the initial margin balance.
Also, there are some restrictions on who can sell short, which stocks can be shorted, etc. You must be familiar with the regulation if want to short a stock. For example, some limitations are put on stocks wit low price.

Who can short stocks?

First of all, it isn’t for amateurs.

Unlimited losses and a margin account can be exceptionally dangerous for an amateur trader. Especially you don’t completely understand the risk you’ll face whenever you enter a short position without protection.
Due to the possible large losses that short selling generates, brokerages lower this strategy to margin accounts. In case you use a cash account without margin, you’ll not be allowed to short selling.
If you’re not a short seller and don’t like your stocks to be borrowed, the best option is to open a cash account. That will hold away short-sellers to borrow your stocks without your personal permission.
This is usually good practice, anyway.

Is timing important for shorting a stock?

In short, yes. The most important for shorting a stock is to know which one or more could be overvalued, also when it may drop, and when it may rise in value.
Shorting a stock is possible because the stock can be overvalued. For example, the housing bubble in 2008. Firstly, we had an enormous increase in housing costs. So, when the bubble popped we had a correction in the stock market. Remember, stocks can be overvalued or undervalued. In shorting is important to know which one is overvalued.

How long to stay in a short position?

You can enter and exit a short position on the same day. Or you may hold on the position for several days or weeks depending on the strategy and how the stock is performing. Timing is especially important to short selling. But the possible influence of tax practice is important also. So, we have to say, this is a strategy that requires practice and study.

Tools for shorting the stock

Shorting a stock is a strategy that demands to identify winners and losers.
For example, you may choose to go long a carmaker because you expect it’s possible to take market share. But, at the same time, you can go short to another carmaker that might sink.
Shorting is useful to hedge the current long position. For example, you hold stocks of the company and you expect it to decline in the next few months. But you don’t want to sell that stock. So, you could hedge the long position by shorting that stock while expecting it to decrease. When the stock turn to grow again all you need is to close the short position.

But you must be very careful.

Shorting a stock appears as very simple. But, keep in mind, this isn’t a strategy for beginners. Only the advanced traders who recognize the potential problems should think about shorting.

A valuable tool is the “short ratio”, you can see it specified for each individual stock. The short ratio commonly means how many days the stock needs to cover all the short positions. However, there is another benefit to that figure. It reveals the number of shares that are currently shorted by traders in comparison to the number of shares that are available overall.
How to get this number?
Multiply the current short ratio by the 30-day average daily volume of stocks.
Just use it as a quick measure of investors’ sentiment towards a stock. For example, a high short ratio usually shows the belief that stock is falling. There are some exceptions, but understanding those exceptions is the key to victorious short selling.
Stay tuned!

7th February 2019