How to Short a Bouncing Market

Steve Kanaval |

stock markets today, shorting the market, shorting a stock, market bounce, stocks to buy nowIf one were to rank the difficult trades in order I think nearly all portfolio managers would say the order goes something like this.

1.) Adding to a short position in a falling market during volatility (selling weakness)

2.) Adding to a long position in rising market at expanded valuations (momentum buying)

3.) Buying pullbacks (value buy)

4.) Shorting a bounce off the bottom (value short)

We will take example #4 because this is where we are now. We’ll establish an initial short using a liquid ETF and come back to this trade later and explain and implement #1 as a second part of it. I will also explain why the second part of the trade will be the most difficult yet the most profitable.

Rather than trade FANG (FaceBook ($FB), Amazon ($AMZN), Netflix ($NFLX), Google ($GOOG)), we will use the SPDR S&P 500 ETF (SPY) for this example as it will be easier to follow.

Let's start with where we are now, using our ETF example SPY trading near $200.00 + 2% in premarket trading. We need to establish a 40% position immediately so we will short 40 shares at this 199 to 200 level to start. You can click here to see the live P&L. We will ultimately short 100 shares - but need to open a core position to start, and this can be done pre-market in liquid stocks like SPY.

We have pre-set levels to add to the short if the market rises, and we have a plan to add if the market goes straight down from here (employing #1) above. For measuring purposes we established a short at 199.45 during premarket and opening trading for this exercise. Click on P&L link to see how this is performing.

This trade is described as #4 above as we are establishing a short position into a bounce. As I look at the market, I hope we get an extended quick bounce where I can get 100% of my trade in place. Just a caution, this rarely happens perfectly, but setting up the entry become pretty mechanical after done a few times.

The remainder of the trade will happen over the next few trading sessions, but the important thing to know, is that the trade revolves around price, NOT time. In the case of our example SPY we would like the market to rally to 208 where we would have 100% of our position in place selling into the rally at each even number 200, 202, 204, 206, and 208. This is called a "short scale" up entry, with the final 20% coming at 208 and 10% at each scale level. Please refer to the Live P&L to see if the trade took place for our example.

Entering and exiting trades can never be an emotional reaction, it must be a very methodical process only based on execution and proper record keeping. The only thing that matters in these trades is how much money you make, these are never cocktail party chatter nuggets, because most will have zero idea what you are talking about. But I can tell you what you are doing here is shorting a bounce before the market falls. The interesting part will be fighting your instincts to take profits and add to this trade.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
FB Facebook Inc. 119.68 0.77 0.65 17,464,736
AMZN Amazon.com Inc. 768.66 1.33 0.17 2,470,923
GOOG Alphabet Inc. 789.29 12.87 1.66 1,821,914
NFLX Netflix Inc. 122.88 -0.36 -0.29 4,700,783

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