Personal Finance

Ten Roadblocks to Profitable Short-Selling

12/05/07 - 01:03 PM EST


This column was originally published on RealMoney on Nov. 29, 2007 at 12:46 p.m. EDT. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.

Short-selling sell-short has come back into vogue in recent months, with the major averages average convulsing in response to the mortgage crisis. In fact, we've seen more downside pressure this year than at any time since the 2000-to-2002 bear market. This decline has forced a cadre of long long-position-only traders and investors to revisit this classic strategy.

But short-selling's popularity can be a contrary signal, because bad things will happen when that side of the market gets overcrowded. This is especially true after amateur shorts apply the same methods they use in their stockpicking, but in reverse. In other words, they chase downward momentum without an understanding of the considerable risk risk.

Despite the threat of unexpected squeezes, short-selling could be the hottest game in town in 2008. Just keep in mind that it's still not easy to make money selling first and buying later. In fact, most readers will stare at falling prices for hours, and then enter their sales at exactly the wrong time. This is one of the great truths of this trading methodology.

I've compiled 10 of the most common roadblocks to profitable short-selling. Review the list and understand why this practice can cause so much pain and suffering, when misapplied. Also, remember that a downtrend makes short-selling even tougher at times, because it's harder to find your edge against other traders playing the same game.

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At the time of publication, Farley had no positions in the stocks mentioned, although holdings can change at any time.

Alan Farley is a professional trader and author of The Master Swing Trader. Farley also runs a Web site called HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback; click here to send him an email. Also, click here to sign up for Farley's premium subscription product The Daily Swing Trade brought to you exclusively by TheStreet.com.

TheStreet.com has a revenue-sharing relationship with Trader's Library under which it receives a portion of the revenue from purchases by customers directed there from TheStreet.com.


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