Winning Trading with a Good Short Game

a good short game

In trading, as in golf, the importance of having a good “short game” simply cannot be overstated.

It remains true that the majority of traders seem to have a built-in prejudice against selling short, and a corresponding predisposition to buying long. This has been particularly unfortunate for some traders in the recent past – using the futures market as an example, virtually the entire market was essentially a bear market throughout the last two decades of the 20th century.

If you weren’t a good short seller, that’s a 20-year period during which it would have been very difficult for you as a trader to make any money. (I’ll just note here, for those of you who may be trading it, that the overall bull market in basic commodities that began around the turn of the century is likely to continue for at least another three to five years.) However, even bull markets have down cycles in them, and so it’s still important to be ready to go short when it’s appropriate, even when the overall market trend is up. (Cocoa, in the 1990’s, after rocketing above 20 for the first time in decades, came almost all the way back down to its original take-off point before shooting back up – the perfect play would have been buy-sell-buy, much more profitable than a “buy and hold” strategy.)

The first step in becoming a better trader is simply an awareness of this basic prejudice that most of us have toward playing the buy side over the sell side.

The interesting fact is that it’s really easier to make money from the short side than from the long side, as markets always tend to fall more rapidly than they rise. Markets climb up, but they fall down. Investors are much more prone to panic selling than they are to panic buying, and just as in the physical world, it’s simply easier to fall down a mountain than it is to climb up one. Therefore, if one correctly enters a market on the short side, he or she is more likely to see a quick, significant profit than is usually the case with adopting a long position.

I also believe that a study of historical market statistics would reveal that a bear market tests tops, both long term tops and swing highs on the overall way down, less frequently and intensely than a bull market tests long term or retracement lows.

What this means for a trader is that, when selling short, one generally doesn’t have to take as much heat worrying about being stopped out of a position as is the case when buying long, and therefore a trailing stop can be more effectively used – protecting one’s overall equity while ideally keeping one in the market for more profits.

Take a look at the two 4-hour Eur/Usd charts below, the first one showing a recent market top and the next one a recent market bottom (the top and bottom are located right around the middle of each chart, respectively), and note the following differences:

1 – The first dramatic down candle from the top (note that it, and a subsequent big down candle about 20 4-hour periods later, are larger/longer than any up candle showing on the chart). Even though the market retraces back up after that initial drop before falling lower, it never gets within 50 pips of revisiting the top.

2 – The brief time the market gives you an opportunity to get in on the short side at the top vs. how long it lingers near the bottom.

3 – A perfect illustration of the trading maxim that “markets fall faster than they rise” is shown in the second chart. Look at the 10 or 11 candles just before the market bottoms out, and then see how takes the market almost 40 candles – four times longer! – just to get back up to the 1.3650 level from where it had recently fallen.

Eur/Usd chart

Eur/Usd chart

 

It may help to remember things like the fact that the two most legendary (and profitable) trades of the great master trader Jesse Livermore were both short sells. What’s the absolute best trade, the most massively profitable killing that anyone could have made in the last century? – Selling short the stock market in 1929. Livermore did just that, and reportedly made $100 million in the space of just a few days during the October 1929 crash, while a lot of other traders were going broke.

I have tried a number of methods over the years to help traders get over their innate prejudice to be buyers rather than sellers. One has been to try to get them to just look at their market choices in other terms besides the traditional notions of “up” and “down”. Try thinking, instead of choosing between up and down, choosing between “right” and “left”. Or look at the two options of market prices going either up or down as being like the two options of “red” and “black” in roulette (fortunately, we don’t have to worry about zeroes or double-zeroes on the wheel in market trading). At any given moment, with every new spin of the wheel, the odds are perfectly even between the two choices. Such new perspectives, just a little twist of the kaleidoscope one views the market through, can help one more clearly see that the market itself has no built-in preference for price movement up or down. Once you clearly realize that fact, it becomes easier to adopt and maintain a similarly neutral position, one that’s not overly inclined to favor long positions over short positions. I’ve said it before – One should love and hate all currency pairs equally. Don’t fall in love with Usd, Aud, or any other currency to the point where you always and only play the buy side – be ready to pounce on the short side and sell it to death when that’s the way the market is clearly going.

There are not very many guarantees in the world of trading, but I can absolutely guarantee you this: Your trading will be more successful when you are just as willing to sell a market as you are to buy it.

As always, I am open to receiving your thoughts and comments. (If anyone’s feeling particularly generous, I could also use a new Corvette.)

Jack Maverick

Jack Maverick is a writer and forex trader. Find him on Google+ at https://plus.google.com/u/0/103534926809963693894/?rel=author and check out his novel, the psychological thriller “A Cross of Hearts”, on Amazon at http://www.amazon.com/Cross-Hearts-J-B-Maverick-ebook/dp/B006GHJ0ZC/

 

 

 

 

 

 

 

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