So you want to be careful not to take unnecessary risks or to overextend yourself
Money Management and Psychology
You are probably interested in selling short to make money to improve the quality of your life. So you want to be careful not to take unnecessary risks or to overextend yourself. If you do, you will likely make yourself miserable from worrying about your stock price movements or the losses you may be suffering.
The financial skill most difficult for many people to master is the management of their own emotions. It is very hard to invest successfully while afraid, greedy, or complacent, or angry, stubborn, or desperate. It is important to take risks that you can live with and to protect yourself against unnecessary risks.
Limit your losses. If a position starts going against you, get out early. Sometimes your judgment will be mistaken. Recognize it early and close out your position. You may take some losses but you will still have enough money left to open another position. By closing positions early you may miss out on a price movement that would have made your position a winner, but that is the benefit of hindsight. At the time, the available information showed your timing or your judgment on this particular transaction was off.
When you have a successful short position, do not close it out prematurely. The falling price of the stock confirms your judgment. After all you went through to identify the stock to short and the timing of the sale, take advantage of your good fortune.
Eventually, the downward price movement will stall and the stock price will start to recover. Then if, in your judgment, the price is near the true value of the stock, then the time has come to close out your position. Even if the downward price movement stalls at a level that you believe is still overpriced, it is often best to close out your short position. Compare the few extra dollars you might make against the chance of losing a great deal of money if the stock price recovers strongly. When you examine the risk/reward tradeoff, you will probably be better off closing out your position and finding a new overpriced stock to short.
Enjoy the short side of investing! Good luck, but understand the risks and exercise caution. |
