The Secret To Turn Losing Stocks Into Winning Trades

Written by John Stuart on January 30th, 2016

The Secret To Turn Losing Stocks Into Winning Trades

A red flashing screen!

There’s nothing worse than seeing stocks you’re trading suddenly tank and lose you money.

Those red flashing numbers…

That feeling in the pit of your stomach…

Urgh.

I hate that, and my account balance does too.

But what if I told you there was a way to flip the situation around.

A way you could actually make money off of losing stocks?

A secret you can use to turn losing stocks into winning trades.

Well, there is!

And I want to show it to you…

 

How To Profit From A Falling Stock Price

 

It’s a method called ‘going short’ (or selling).

It’s pretty much the opposite way most traditional investors and traders make money in the market.

You see, unlike buying a stock (or ‘going long’), going short (or selling) involves you finding a stock or derivative you feel is overvalued and essentially betting that the price of it will fall.

The difference between where you got in and where it falls to is what you take home as a trader (minus the costs of course).

So, when you go short, you end up selling a security you don’t actually own, hoping that you can purchase it back at a price lower than that what you got in at.

As I mentioned, when you do this, that difference is what you'll make in profits.

Short Selling is a little more complicated than simply buying a share for capital gain.

You see, when you borrow securities from traders who actually own them, you pay a fee for this.

When you put on your trade you're effectively agreeing on a deadline that you need to buy the stock back and then return it to the original trader.

WARNING: Short selling can be very risky.

Why?

Well, when it comes to short selling the losses you could realize don't have a limit!

That’s right, you could stand to lose more money than you actually have in your trading account.

When you buy stocks, or go long, you’re hoping for the stocks price to run higher (and in the process banking you a decent profit)

However, if the position moves against you, that is if the share price drops instead of rising like you’d hoped, the biggest loss that you could take is the initial amount you forked out for the stocks (IE your long position).

When you go short though, the biggest profit you could bank is 100% of your original position (this will be magnified if you're trading a geared product of course)

But your losses are potentially unlimited, as the shares could soar (going against what you’d anticipated by going short), which you’d be liable for.

If you decide to short stocks (or any other security, such as a CFD), make sure you have an exit plan in that your stop loss levels have been set.

That’s why it’s extremely important to trade short positions very carefully.

So now that you know how to cash in on falling stocks, what next?

 

3 Tools You Can Use To Bank Profits In A Falling Market

 

You’ve done your homework.

You’ve put in the hours.

The analysis is all pointing to one thing.

You fancy putting on a short!

What trading instruments can you use to do so?

Let’s have a look at three of them…

 

Short Position Play #1: Contracts For Difference (CFDs)

CFDs are possibly one of the most popular trading instruments and derivatives.

All they are is a contract between you and another trading party to exchange the difference between the opening price of a share and the closing price of a share.

You can even use them to trade indices!

What I love the most about CFDs is that you can use them to trade in both directions.

So they’re perfect for potential short positions.

Even better though is that you can magnify your profits

But the same applies with anything trading related.

Gearing can be risky, and you need to be 100% sure of what you’re doing and not gear yourself to the hilt.

You can trade CFD’s through pretty much most brokers on the market or any company that offers CFD trading.

 

Short Position Play #2: Spread Trading

Spread trading is a way to trade an amount of your choosing on which way a share will move.

You can do this to speculate on both rising and falling shares.

A spread trade is also known as relative value trade, and involves the simultaneous purchase of one security and sale of a related security, called legs, as a unit.

Spread trades are usually executed with options or futures contracts as the legs, but other securities are sometimes used.

You can spread trade through a trading company.

The risks don’t change though, so if you do decide to short the market or a specific share, make sure you have a thorough understanding of the instrument and the risks involved.

 

Short Position Play #3: Single Stock Futures

Single stock futures were extremely popular a few years ago and were at one stage the instrument of choice for South African traders until the CFD rolled around.

Single stock futures are basically contracts you can use to trade the market.

As well as using them to buy shares or indices, what makes them great vehicles to use during falling markets or share prices, is that you can use them to short shares or indices.

To trade single stock futures, you’ll need a derivative trading account with a stock broker.


Let’s say at this point you want to run with a market ‘favorite’ in CFDs.

But you know there are risks involved, and you want to improve your chances of success.

Well, you’re in luck.

I have 6 very easy rules for this exact situation…

 

6 Ways To Improve Your Chances of Making Money From Falling Prices

 

I’m sure by now you’re aware of the dangers a bad short position can bring with it.

So how exactly do you dodge the danger?

That's where my six rules come in, follow them to improve your odds when going short.

 

CFD Success Rule #1: A Question of Time

Timing is not just an investors game.

Even if we traders are only in it for a few hours, days or weeks.

That’s why when you go short you need to make sure you’re doing so at the ideal time.

You need to put in the legwork.

You need to do your analysis.

Ignore the “talking heads”, and put in your own graft.

Because at the end of the day you are responsible for the position you put on, not the analyst whose morning note you might subscribe to.

(I promise you, he doesn’t really care much about your trades).

So, make 100% sure before making any semblance of a decision!

 

CFD Success Rule #2: Don't Take Too Long

Because CFDs are geared, smaller price moves could equate to big percentages in your account.

The last thing you want to have happen is to be geared to the hilt and a 2% move loses you 20% in an instant.

That’s why it’s best not to hold your CFD positions for too long.

You risk the stock price heading the opposite way the more time you hold your trade.

And because you want a price to fall to make you bucks, that’s not exactly ideal…

 

CFD Success Rule #3: Trade The Trend

You’re not exactly going to be placing a ton of shorts in a bull market are you?

Well, that’d be more than risky to say the last.

That’s why you should focus on bear markets.

That is, when markets are heading downwards.

This increases the chance of success as the market is in a downtrend.

As I just said, shorting in a bull market is risky.

Personally, I wouldn’t.

You’re more than welcome to try it, just don’t come crying to me when it goes sour.

 

CFD Success Rule #4: Don’t Forget The Basics

Remember, the themarket as a whole biased to continue upwards.

Warren Buffett even coined the phrase, “Over the long term, the stock market news will be good”.

And that’s why shorting can work against you.

Or at least it means that the market is not tipped in your favor.

When you place shorts you NEED to be aware and focussed, and you need to be strict about your stop losses.

I’ve watched traders blow entire accounts because they used their stops as a guideline rather than a hard and fast rule.

Don’t be that guy.

 

CFD Success Rule #5: Don’t Become An Inadvertent CEO

The last thing you want is for your short position to turn you into an inadvertent CEO.

What does that mean?

Well when you go short, if the stock you’re selling (shorting) pays a dividend, you need to pay from your account.

So, don’t forget about the dividends when going short!

 

CFD Success Rule #6: All that Glitters…

Make sure that the market or share you’re looking to short actually has a CFD.

There are a number of different shares that offer CFDs you can trade…

But you need to know that you might not be able to short all of them!

Your broker will be able to indicate which stocks you can’t short.

Ask them for this list, and keep it close.

 




 


 

Profit From Losing Stocks Today!

 

Shorting in itself is almost an art.

Not many traders I know can do it successfully.

But the ones that can smile all the way to the bank!

Just because a stock is dropping, it doesn’t mean the profit opportunity for you has disappeared.

Thankfully there are instruments and methods you can use to take advantage of such moves.

And in the current climate, they’re happening more and more!

Remember, as a trader you WANT a volatile environment.

It means more opportunities for you to trade, which means there’s more opportunity for you to make money.

And short positions are a great way to do this!

If you’d like to increase the odds of your CFD short trades, remember my six steps.

  • Timing is important, you want to be getting in for the RIGHT reasons.
  • Keep it short (see what I did there?), only hold your CFD positions for a short period of time.
  • Trade the trend, and don't fight the market. Trade what you see and not what you believe.
  • Don't forget the risks. This might seem an obvious one, but the market has an upwards bias, don't forget that.
  • Don’t forget about the dividends! The last thing you want to do is pay out money because you didn't pay attention!
  • And lastly, make sure that the market or share you’re looking to short actually can be shorted.

Until then, here’s to profitable trading. 

John Stuart

John Stuart
Content Director
The Money Lab