When thinking about establishing any trading strategy, considering your timeframe is very important. With bearish strategies, however, it may be even more critical to your success due to the potentially unlimited risk involved.
The overall market trend is important in bearish trading
One key component when considering any trade is timeframe. Simply put, how long do you intend to be in this trade? As with many aspects of trading, there is no right or wrong answer to this question. Some traders buy stock with the intent of holding for years while others will buy for shorter term trends such as weeks to months. The most aggressive traders may hold positions for seconds to minutes. It’s true that any timeframe can be effective. The key is to make sure that you have some expectation and understanding of what timeframe makes the most sense for the trade you are about to enter, and to act consistently.
Considerations to take into account before entering a bearish position
When discussing “bearish trading” we’re not talking about standing by idly without a position. Instead, we are establishing an actual short position in a given security or index.
Historically, the stock market has spent more time going up than down. When you buy a stock, the worst that can happen is that the company goes out of business and the stock goes to zero. However, short positions have unlimited risk. If you sold shares short in the open market, your requirement to close out the trade is to buy those shares back, ideally at a lower price. If the price of the shorted security rallies against you, it can go perpetually higher. As such, it is less common for a trader to sell short a stock and hold that short position for an extended period of time. With this in mind, it’s important to consider your timeframe for a short trade before entering the position. You can change your mind as the circumstances change, but having an idea of the possibilities will prepare you to make a decision in the moment.
Often, the decision of timeframe for your short trade will be based on one or both of two factors:
- Personal preference based on individual temperament and risk tolerance
- The catalyst
Factors in choosing trading timeframe: personal preference
The question to ask is not “Which time frame is best?” but rather “Which time frame am I most comfortable with?” Consider what would happen if the long-term trader decided one day to suddenly start jumping in and out of positions, or if the usually short-term trader started trying to hold onto positions for months at a time. Chances are, both traders would eventually feel uncomfortable sticking with their new trading time frame.
Before you sell short a stock with the intent of holding the short position for a long time, it is wise to realistically assess your ability to hold onto positions when they move against you.
Factors in choosing trading timeframe: trade catalyst
If you expect a particular company to see a significant slowing or a decline in sales and earnings, it is reasonable to expect that, absent other factors that may affect price, the price for that stock may decline over time. If a company’s fundamental outlook truly takes a meaningful turn for the worse, then it could be a candidate for a short position. Most traders who trade the short side will look for shorter-term opportunities in order to limit their risk.
If the catalyst that prompted the trader to enter a short position may require time to play out, then a short-term trading timeframe does not make sense. If a trader sells short a stock because the company has stated that they expect demand for their key product to decline in the years ahead, then the trader may need to give the position some room to fluctuate. Price swings over the long term can often be much greater than those in the short run so appropriate position sizing is important as well.
At the other end of the spectrum, if a trader expects a stock to drop sharply right after what he or she anticipates will be a negative earnings announcement, for example, then planning to sell short before the announcement and buying back the shares soon after could be a consideration.
As an alternative scenario, a trader might choose to enter a short position in a down-trending stock and maintain the short position until its trend is broken. In these instances, the trader may not be concerned with the time frame.
Possible dangers when considering trading timeframe
The biggest dangers regarding trading timeframe in bearish trades tend to occur after the trade is established. Examples of these types of potentially dangerous actions may include:
- Entering a trade based on a short term strategy and then deciding to hold for the long term after the stock moves sharply against you.
- Entering a trade and expecting to get out with a quick profit if the stock moves in your favor, then deciding to hold on for a little longer after the anticipated short-term selloff occurs.
While each of the moves listed above may work out for a given trade, in the long run, the act of routinely changing the expected trading timeframe based on whims and random events is not recommended.
Each individual trader has personal preferences regarding how they will choose a trade, what they will trade and how long they are comfortable holding a given position. When it comes to such personal preferences, there are no right or wrong answers. What is most important is that a trader analyzes and acknowledges their own preferences and acts in a manner that offers them the greatest opportunity for long-term success. Trading timeframe is an important consideration in that process.