Momentum Trading: Aggressive and Profitable Bear Strategy

Aug 5, 2020 03:40 AM ET
Momentum Trading: Aggressive and Profitable Bear Strategy

Momentum trading is an investing strategy that entails taking short term positions in the market, to profit from changing market volatility. The idea is to sell losers in the market and invest the same money on securities beginning to boil. Likewise, traders let winners ride until the market reverses.

The trading strategy favors situations where price fluctuates widely due to high levels of volatility. In this case, a single trade, short or long, can become profitable in a matter of minutes. However, the strategy requires sophisticated risk management strategies, given that volatility is a double edge sword.

Momentum trading sees traders open short and long positions to take advantage of extreme volatility that triggers wild swings.

Difference between Short and Long Trades

A long trade is initiated when purchasing a security in anticipation of price edging higher in the future. In this case, traders purchase securities to sell in the long run as soon as the price goes up. Up movements in the markets usually accompanied with slow and consistent buying volume, created by mutual funds, banks or investment firms. As they don’t buy securities in “one print” the bull trends are always much longer then the sharp sell offs. 

Difference between Short and Long Trades

With long trades, the profit potential is unlimited, given that price can move up indefinitely. For instance, if you buy a stock at $2, the price can run to $10, $100 or even $1000. In this case, there is no limitation to the extent to which price can move. So what about selling?

Short operations, on the other hand entail selling security in anticipation of price moving lower. In short selling, traders borrow shares or stocks, hoping that price will drop significantly. Momentum traders sell assets before buying them as soon as the price drops or even earlier. With shorting or selling of securities, profit is limited, given that price can only drop to $0. The risk, on the other hand, is unlimited given that price can rise indefinitely.
As it usually happens much faster traders have to be confident, cold minded and ready to execute at a high speed.

Of course no one sells an asset because of great news. When you’re a fund, bank or a big investor that is losing money - fear is leading you to act irrational and that feeling is way stronger than greed. That leads to a significant price decline. As soon as markets go into a free fall, momentum traders use it to enter short positions. The market conditions here  provide an ideal situation to make money faster than buying and holding.

So what reasons can trigger the selling pressure, that’s creating opportunity for our Bear Strategy?

Perfect stock for your big intra-day short

Short selling stock can be tricky, given that one is essentially betting against a company’s future. However, some situations present an ideal opportunity to enter short positions.

Perfect stock for your big intra-day short

Company facing an Uncertain Future

The best stocks to short are those of companies facing an uncertain future. Upcoming news lowering investors expectations, fraud investigations and unexpected earnings and revenue declines are fuelling the sell-off wave. A company whose losses keep on piling at the back of stagnant growth would be ideal to short in this case.

Earnings miss as well as a string of bad news most of the time, spell trouble affirming the need to enter a short position. Companies facing stiff competition in a sector also tend to elicit strong short-selling pressure.

Stock is Down 4%

A stock that is down significantly. Usually by more than 4% while the overall stock market is trending upward could also fit the bill for a short sell. A 4% drop many at times signify surging short-selling pressure on investor confidence about the company's long term prospects waning. A drop would be followed by a weak pullback signaling that a stock is likely to continue trending lower for an extended period. 

Stock is Trading below A key Support

A stock that struggles to break through a critical support level would also fit the bill for a perfect short. Failure to break through could signal weak buying pressure as short-sellers remain in firm control. Likewise, it could indicate that underlying fundamentals are not strong enough to justify any upside action.

Stock has a Weak Rebound

Whenever a stock moves lower for an extended period it better be followed by a weak rebound. The additional signal for a longer bearish outlook helps you not to sell in the low, where the smart money can come in and buy out the undervalued asset. A weak rebound comes about on short-sellers exiting position on profit-taking and pressuring the market lower. Bulls here are not coming into the play and the “last guardians” of long positions are starting to panic, which causes the second wave.

Weak rebounds, most of the time, provide ideal entry points for short-sellers who have missed out and for ones that are willing to expand their position.

Wirecard: The Perfect Example

Wirecard: The Perfect Example

Here is the classic case for this strategy. Wirecard was a multibillion Fintech startup from Germany. The news on investigation, bad audit results and possible $2 billions missed from company accounts sent the stock price into the free fall. 

Here is what the bears wanted: bad news, breaking the key support, and trading much lower than -4% from the previous day close. Let's look at it closely intraday:

Wirecard: The Perfect Example

We can see that the stock price declined from $100 to $40 and then rebounds to $60. This is a 30% rebound from the initial move. Doesn’t look like any strong buyers are interested in this stock right now.

The touch of 21 moving average gives traders a perfect short sell setup with low risk and high possible return. All the traders need to do is to trail the stop beyond moving average. Breaking the previous low of this free fall gives an opportunity to build a bigger position, with almost no risk, because the trade is already in the profit zone.

Covering the position on the bullish crossing of the 21 day MA will leave momentum bears with 30$ from a $60 stock. If speculators are fine with holding short positions overnight -  keep a part of it. because eventually the price of Wirecard dropped to 1.50$. But that is whole another story.

Conclusion

Short selling is an aggressive trading strategy that allows traders to profit on prices moving lower. It is popular among momentum traders as prices tend to move lower much faster than trending up. 


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