As stocks dropped another 2.5% Wednesday into correction territory, it’s no surprise I’m a full-on bear in my Trader’s Advantage service with our main strategy right focused on shorting a stock.
Shorting a stock may seem like an exotic activity, but it’s really not. On the most basic level, you are simply betting that the value of a security or index will go down.
What literally occurs when shorting a stock is that you must borrow a stock on margin and sell it. To short a stock, you borrow the shares from your broker, and then sell those shares to the open market. Because you’re selling something, you collect the money at the start of the transaction, just as you would if you were selling a car, a phone or any other item.
Then when the stock declines to the level at which you want to take a profit, you buy it back—the technical word is “cover”— and return it to the lender. You pocket the difference between the sale price and the cover price. The general idea is to sell the shares high, and then buy them back later at a lower cost to return them to your broker.
You must have a margin account and permission from your broker to short a stock. Each broker will have slightly different requirements for opening and using margin accounts but, in general, to open what’s known as a Regulation T (or “Reg T”) margin account, you just need $5,000 in additional money that is not allocated to any other securities. Your broker can answer specific questions about any other requirements and fees associated with shorting.
When shorting a stock, to initiate the trade, you “sell to open” the shares. To cover a short trade, or when you’re ready to close it, you “buy to close.”
Again, your broker can help you review other requirements for shorting a stock, but it’s a strategy I sometimes use to make quick profits when stocks or entire indices go down, and I see an opportunity traders can take advantage of now.
Medical device maker Medtronic (MDT) hit a wall at $78 and has been coming down steadily all year. The chart looks exactly like the “Dome of Doom” of the broader market.
Healthcare stocks have come under a lot of fire of late, possibly because of fears that the presidential nomination battle is going to feature a lot of talk about forcing the drug makers and medical-device makers to bring prices down. Figure that very few major stocks are going to get away from this difficult period without sinking near their August or October lows.
Make no mistake: This is a good company for the long haul, but the technical signals are relaying that shares are likely to round-trip to the low $70s in short order.
I recommend shorting, or selling to open, MDT shares at about $74.50.
Set up to cover and buy back to close half of the shares at my initial target $71 and the rest at the final target $68.
Set a stop to buy back and cover MDT at $78.75 limit, good after 10:30 a.m. ET only.
Jon Markman writes a daily trading newsletter, Trader’s Advantage, and CounterPoint Options, a service geared towards helping individual traders make steady, consistent profits with the VIX. Follow him on Twitter for his latest take on markets and innovation.
