Selling weakness is a CFD trading strategy for use in a bear market, and it exploits the existing trends to achieve excellent results. As a trend following strategy, it uses the flow of the market to profit from falling prices. As share prices tend to fall more quickly than they rise, profiting from going short as in this strategy can be rapid and effective.
Using CFDs for short selling a share is an efficient way to leverage your trading capital. Apart from being able to trade on margin, when you short sell you receive interest to your account for the days when you are holding that position.
To be sure that the trend is strong, you need to confirm the downtrend in three ways. Firstly, you want to see that the market as a whole is declining, and you can confirm this by checking a long-term moving average and making sure it is consistently going downwards. You will also want to see that the stocks sector is declining, and can use the same means of checking this, or perhaps just use visual inspection of the chart.
When you are determining that a solid downtrend is in place, you need to check on several different time frames to make sure that you get the same result. If you don’t do this, you may be fooled by a counter trend move which lasts for a month or two.
When you have found a situation where the previous conditions are satisfied, then you need to identify a weak stock within the sector. You want a stock which is performing relatively badly compared to its peers. First you should look for a stock that is performing worse than the market as a whole, as defined by the FTSE or other index. Try to find a stock which is at least 10% worse than the overall index. Secondly, you want your stock choice to be doing worse than the sector average, and this may be 2% worse when averaged over the previous month.
One way to identify suitable shorting candidates is by taking advantage of poor trading updates. When a company releases a disappointing trading statement, the stock price will usually fall sharply. Generally the stock will then experience a small recovery in the share price (so called ‘dead cat’ bounce) in the following two or three days after the poor results announcement. This represents a good opportunity for shorting such a stock as the share decline is generally followed by broker downgrades which put further pressure on the share price over the following weeks.
Once you have screened for a suitable stock, you should then take a short position in it using CFDs, as mentioned above, for their leverage. As soon as you have entered the trade, you need to set your stop loss position, and for this trade you should set it just above the high for the last few weeks. If the price goes up to this level, then it’s reasonable to assume that the downtrend is not continuing, and to stop out of the trade for a small loss.
Assuming that the trade works, and that the price of the stock continues to fall, you should set a trailing stop, taking account of the demonstrated volatility, which would protect you from a sudden surge upwards in price. Other ways to trigger an exit from the trade would be to monitor how badly the stock is performing relative to the overall or sector indices. If the stock is not underperforming them, then that suggests that the company is strengthening, and that you should exit your trade and take your profits.
