Scalping 103: Short Selling Stocks

The equity markets have seen unprecedented volatility in 2020 triggered by the COVID-19 pandemic black swan event. The S&P 500 ETF (NYSEARCA: SPY) has broken all kinds of records including the fastest drop into a bear market in history collapsing in excess of (-30 percent) from highs in just three weeks. We covered the arsenal of tools for building an intraday trading methodology in our Scalping 101 article. Our Scalping 102 article reviewed price action pinball illustrating long trades off-key bumpers utilizing mini pups on the rifle charts. In this period of historic volatility, it’s prudent to be able to trade both the long and short side of price action. Short selling requires an extra level of precaution due to the various structural differences compared to buying longs.

The Mechanics of Short Selling

For new traders and investors, the concept of a buying a long position to sell at a higher price for a profit is easily understood. Playing the long side enables you to profit from rising prices. However, it doesn’t enable you to profit on falling prices. In order to profit from falling prices, you would short sell a stock. It requires borrowing the shares (done automatically by your broker) and then selling the shares to initiate the short position. As prices fall, you can buy/cover to close out the position, which automatically returns the shares back to the rightful owner. Widely held and traded stocks are relatively easy to borrow (ETB) to short sell. Stocks that are hard to borrow (HTB) may require a short locate request with your broker. These often come with locate fees, interest fees and higher maintenance margins. For newer traders, its wise to avoid these stocks due to the susceptibility for short squeezes.

Using the SPY ETF as a Compass

By utilizing the rifle charts and Fibonacci (fib) price levels to display the proper bumpers, we can visually illustrate the pinball playing field layout. As outlined in our previous article, scalping is akin to playing a pinball machine and reacting off the key bumpers. In addition to utilizing a 5-minute and 1-minute rifle charts for the stock, we also add a “compass” in the form of the SPY ETF on a 5-minute chart. Functioning like a compass, the SPY provides us with which way the market is moving. This allows us to gauge whether the stock has a positive or negative correlation with the markets. If the SPY rises and your stock also rises, that shows positive correlation. In these cases, you can use the SPY as a lead indicator anticipating a bounce when the SPY bounces and a drop when the SPY falls. If the SPY rises and your stock falls, that shows negative correlation also referred to as “fading”. In these cases, you watch for sell fades to short sell the stock when the upside move on the SPY peaks out. When the SPY falls back down, sell fading stocks tend to collapse much quicker.

Stacking the Short Sell Premises

The key to good set-ups is being able to stack premises for the short ahead of time and as they occur. On the Advanced Micro Devices (NASDAQ: AMD) rifle charts, we can assess ahead of time key “bumpers” where reversions may occur. The 42.80 price level is a powerful 4.618 fib resistance backed by the 42.95 fib. Overlapping fibs make for great bumpers. As AMD rises through the sticky 2.50s range straight through 42.50 and 42.60, that immediately sets up a reversion back to that range. The question is where is a logical peak? You guessed it, the 42.80 to 42.95 fib bumpers. As the 1-minute AMD chart spikes on a high band “climax” mini pup it makes a new high and then a lower high. That is the market structure high (MSH) pattern of a high, higher high and lower high (three candlestick pattern). The short-sell triggers under the low of lower high candle (third candle). We call this the MSH trigger which is set under 42.71. The price premises are the stacked fib bumpers at 41.80 and 42.95, along with the 1-minute MSH trigger at 42.70 and the 1-minute 5-period MA which when rejected will “round out” and slope down forming the stochastic mini inverse pup, which is our momentum trigger. Meanwhile, the 5-minute AMD and SPY stochastic are both forming high-band bearish mini inverse pups which puts the “wind on the backs” of the short. The six stacked premises are:  

1) AMD double fib bumpers including a 0.618 fib

2) AMD 1-minute MSH trigger 

3) AMD 1-minute 5-period MA rejection

4) AMD 1-minute mini inverse pup stochastic (high band at or above 80-band)

5) AMD 5-minute AMD stochastic mini inverse pup (high band)

6) SPY 5-min mini inverse pup (high band)

 

The outcome of these premises enable buy/cover scalps at three price inflection points including 42.40 (sticky 2.50s zone), 42.11 fib and 41.60 fib on the 1-min low band mini inverse pup, which implies a final climactic price drop that shorts can cover final shares before the snapback coil.

Margin Calls and Forced Liquidations

The most dangerous aspect of short selling is getting caught in a short squeeze. This is when prices rise sharply in a parabolic manner with virtually no pullbacks due to insatiable panic buying from shorts trying to cover. This phenomenon occurs frequently with HTB stocks as available short inventory can evaporate quickly. This prevents short sellers from averaging their short position as it moves against them. Often times the maintenance margin gets adjusted during the day which can trigger an intraday margin call without the trader even being aware. Imagine being short a stock and suddenly the four-to-one buying power abruptly drops to one-to-one, this means the 25-percent capital requirement to hold the short position just went to 100-percent capital. If you don’t have the full capital in your trading account, it will trigger an intraday margin call. Your broker may implement forced liquidation which will cause their algos to buy cover shares with market orders to bring your account back into compliance. Your own buying fuels the spike in share prices further panicking other short sellers trying to cover.

Agility

Having the ability to play both long and short price action augments your agility as a trader. Every trader has an affinity to either playing the long side or the short side of price action. Whether you actively short sell as much as going long, having the choice to take shorts is essential for optimal scalping. It also keeps you flexible so as to not get married to a single directional trading position. Short selling can be dangerous with the potential for margin calls, therefore, always manage share sizing along with proper pacing.