When it comes to identifying potential candidates for a short sale, stocks that are trading below a given moving average for several days could be a good place to start. Why? Because when a stock is trending lower, a moving average could potentially serve as a new ceiling.
Let’s look at an example. In this chart, we see an uptrend was in place, with the price supported by the 50-day simple moving average, or 50-SMA. The stock then broke below that level and started a new downtrend. When a longer term moving average like the 50-SMA is broken, it could take time—and potentially several bounces—to test that average again.
Note that the stock actually rebounded quickly after breaking through support, but it still didn’t come close to reaching the 50-SMA. In fact, the shorter-term 10-day SMA ended up becoming a new point of resistance.
Given this setup, a trader looking to make a bearish trade could open a short position and then place a buy-stop slightly above the 10 day SMA. If the 10 day SMA acts as a temporary ceiling, setting a buy-stop above it could be part of an exit strategy and help protect from losses should the stock suddenly break upward.
Stops can be important when you're trying to protect gains made from a long position. They can be just as important when you're trying to short, because you have to buy the stock back to close out your position. I
t’s important to remember, though, that there is no guarantee that a stop order will go through at or near your stop price. Also, in order to do any short selling, you need to have a margin account with your brokerage firm and there is the potential unlimited upside risk of loss. Be sure to use a number of indicators to get added confirmation for any possible trade.
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There are various tools traders can use to identify potential short selling candidates. Learn how using Simple Moving Averages can help narrow down stocks that might be headed for a downtrend.