How To Learn Short Selling With TIM

With all the time I spend scouring the landscape for ideal trades, preaching against random market noise and for disciplined trading, I often forget to explain the bare bones basics. Starting now, this will change—every few days I'll have a detailed lesson. Today, I write about my all-time favorite trading strategy: Short Selling , which involves betting on a drop in an investment's prices.

So, how does this backwards-sounding strategy work? Ever hear the saying “don't sell yourself short"? That means don't believe you can't succeed at something. Well, in Short Selling , that's exactly what you're doing—betting that xyz investment won't succeed at increasing in value. Whether you're betting against a stock, currency or commodity, you're “selling that investment short."

Short Selling is exactly like buying and selling the way that you're only too familiar with except the order is reversed—you sell before you buy. The old adage “buy low, sell high" still applies, here it's just “sell high, buy low". What's worked for me is to short sell when a stock goes up waaaaay too high waaaay too quickly on waaaay meaningless news and buy it back when reason pushes prices lower, back to reality.

How can you sell something you've never bought, ahhhh, this is what confuses soooo many people, you're actually borrowing shares from your broker in order to take a negative position. You're selling shares you don't own. For example, instead of owning 1,000 shares of XYZ when you buy its stock, when you short sell, you own -1,000 shares.

You're actually taking out a loan from your broker, which is why you must have a margin account in order to short sell-sorry IRA accountholders! But don't worry about paying interest, if you're quick—think a few days max, that's what's worked best for me—the interest on that loan is negligible. When you buy it back later, or “buy to cover" your short position aka you're closing out your loan.

On the “Enter Order" page of most online brokers, there are options that say “buy" “sell" “sell short" and “buy to cover"—focus on the last two and that's how you initiate and close out a short position. Some brokers—like my favorite ThinkorSwim—don't even differentiate, so you just click “sell" and then “buy" later to execute a short sell and buy to cover, respectively.

For several reasons, Short Selling has a bad rep—stocks and investments tend to go higher over time, you can lose more than you put in (if you short 1,000 shares of a stock at $5 (costing you $5,000) and it goes to $20, you're down $15,000 or 3x what you put in!) whereas if you buy 1,000 shares of that same stock at $5, the worst it can do is go to 0, losing you $5,000.
Most importantly, corporate management, shareholders and the financial media circus all do everything in their power to push prices higher, ever the optimists, because it's in their interest to do so.

No matter how sensible Short Selling may be, it's a very unpopular strategy because a.) it's often believed to be unpatriotic (nonsense!) b.) risky (not if you're quick!) c.) difficult (nahhhh, just expect the worst in everyone—not very tough to do in this industry) and d.) the risk of short squeezes-when short sellers are forced to buy to cover their positions, either due to pressure from their brokers or because they can't stand the pain of loss any longer, help to squeeze stocks higher violently and quickly (scary, but the key is to short into these unnatural runups, ideally after they've already started downtrending).

This strategy has had its big winners—Jesse Livermore shorting into the 1929 crash, Jim Chanos shorting Enron all the way to 0, George Soros making $1 billion—yes, billion with a B—literally overnight, betting against the British Pound and me. While I shouldn't even be mentioned in the same breath as those legends, I've got a bigger mouth and I'm gonna take this strategy mainstream, showing everyone how it's helped me—an untrained, undisciplined, emotional, ego-driven young guy—avoid never having to get a real job, earning me six-figure annual profits for nearly a decade.

As those of you who've read my book, An American Hedge Fund, or watched my instructional dvd PennyStocking know, I made my first $1 million naively buying hyped up stocks as they surged higher during the tech bubble. Back then, I was fortunate enough not to know you could make money through Short Selling , or betting that stock prices will drop lower because while short sellers who preached that stocks were ridiculously overvalued were eventually proven correct, many went bankrupt or worse, discovering they owed their brokers money (remember, you can lose more $ than you put in!)

Even more fortunate, right as the bubble burst, I learned how to short sell, earning my 2nd million dollars and managing the top ranked short bias hedge fund 2003-2006 (Barclays). A harsh lesson in just how pathetic these companies are helped me understand that hype and manipulation pushes undeserving stocks higher, there are tons of idiots on Wall Street and many companies will fail, so it's only natural to bet on failure in addition to success.

The harsh reality is that companies, especially smallcap and microcap companies, take advantage of any significant increase in stock price to raise capital, diluting their stock—as FEED just proved the other day.

Unlike Chanos and Soros, I've never had the patience to hold for any truly momentous gains, a result of my ferret-on-crack-like patience. Nevertheless, the keys to my success: thinking the worst of everyone and every company, trading scared and conservative (taking profits of 50 cents to $2/share then moving on) and waiting for the opportune times to strike—that being when all that hype and BS inevitably come crashing down in one quick or gradual revelation.

I'm talking about shorting hyped-up stocks with near-vertical charts or those that have risen exponentially, like from $4 to $12 within a few days and betting the price will drop a little. It's truly beautiful when it happens, but mind you these wonderful opportunities are rare so have the patience to wait for them.

Luckily, there's many different ways to short sell, so if you don't like my niche trading strategy, definitely check out the only 2 other books on the subject, both of which I've found helpful. You can find these books at my website by clicking on one of the links below in the biobox.

The Art of Short Selling
How to Make Money Stocks Selling Short