The key to surviving this market

One comment made to me by a reader recently was that while I have been bearish
for a while, I have not done any detailed articles on shorting. That’s true. I
may look to discuss shorting techniques in more detail soon, but today I thought
I would talk a bit about the mindset needed to make money selling short in a
bear market environment.

Bear market environments do not act as mirror images of bull market
environments. Turning a graph of a bull market upside down is typically not a
good representation of how a bear market will act. This is because they rule by
different emotions. Bull markets rule by greed. Bear markets with fear.

Fear is more powerful and causes sharper reactions. It is also pervasive. It is
not only what causes the market to trend lower, but it is also the emotion that
rules the rallies. Rallies in bear market environments are especially fierce.
People who are short become afraid of losing all their profits and are forced to
cover as the market begins to bounce. Additionally bottom pickers rush in for
fear of missing the bottom. Many times these rallies are sharp enough to
temporarily take out resistance levels in stocks and indices. This tends to fool
many investors and technicians. To profit in an environment that is susceptible
to such sharp, short-covering rallies, traders need to be willing to shorten
their time frames and take profits more readily.

This applies to short trades as well as long trades. While ideally you would
like to remain short for the bulk of an extended down-move, short-covering
rallies can make it difficult to do. Therefore, taking partial profits at
opportune times can help greatly in being able to stick with a short position.
There are two instances when I will typically look to take some short-side
profits. The first is when there is an especially sharp move in my favor. The
second is when the market is extremely oversold and I believe a short-covering
rally is imminent.

By taking profits along the way, it can take some of the fear out of one’s
trades and make it easier to withstand short-covering rallies and hold on to
one’s remaining short position. The highly volatile and fear-ruled atmosphere
prevalent in a bear market environment make partial profits more important than
normal.

Best of luck with your trading,

Rob Hanna