#4: Don’t View Long and Short Trades Through the Same Lens
While traders have equal opportunity to go long or short, that doesn’t mean the two trades should be evaluated the same way. Crestmont Research has calculated that from 1950 through 2012, the S&P 500 rose on 53.6% of the calendar days while falling in just 46.4%. Even during 2008 and the bear market period from 1966 through 1982, stocks had slightly more up days than down days.
This means a short trade, by its very nature, has the odds against it right from the start. Bets against the market or individual stocks therefore need to be made on only the most selective basis. If you go back through your trade records and see half or more of the trades were shorts or put purchases, that might demonstrate a naturally pessimistic streak that is likely to prove destructive over time.
The antidote is to create a much higher hurdle for what constitutes an acceptable short trade. Buying when a stock is blown out to the downside is much more likely to pay off than trying to call the top in one that’s taking off. Which bring us to the next rule …