One, two, three steps to shorting stocks

I want to share a quick short setup in the S&P 500 index today. This is a repeatable pattern, and draws on many elements I have discussed here on my blog, and also in my book, The Art and Science of Technical Analysis. Take a look at the daily chart of the S&P 500 futures:

A short setup in the S&P 500
A short setup in the S&P 500

Here are three quick points that set up an excellent short entry:

  1. A new momentum low, relative to recent price history. In this case, a new low on the MACD provides a quick, visual marker for this new downside momentum. Strong momentum usually leads to a retest.
  2. The market pulls back. There’s no moving average magic or anything here, but the market pulls back from the extension is a fairly orderly fashion. (These posts on pullbacks (here and here) will give some insight into the pattern.) Don’t worry about what you label the pattern or if it conforms to some classical chart pattern–leave these arguments in the chat rooms and focus on what the pattern is doing, which is correcting the short-term downward extension.
  3. The market rolls over, which could be the beginning of another leg down. Where and how you enter is subject to a lot of personal taste, but the MACD fast line hook provides another quick confirmation.

I think there’s an important point here, that has the power to change your trading mindset. Why am I short stocks? Not because of anything the Fed might or might not do (that’s one of the biggest places people are wasting time and mental energy right now), not because of any political opinion, and not even because of any arcane technical indicator. (I’m sure we could find some Fibonacci stuff here that would please the True Believers, but you don’t need it to trade.) I’m short because of a simple pattern.

Furthermore, I know what has happened, over tens of thousands of similar patterns in all markets and all timeframes. I know the coin is slightly loaded–the odds are slightly tipped–in favor of my short. Will stocks collapse 45% next week? Maybe. Will the market spike higher tomorrow, ripe the face off all the shorts, and not look back? Maybe. I don’t know, but I do know if I do this trade over and over, with correct stops and correct trade management, I’ll very likely make more money than I lose, and that, friends, is the best we can hope for with any trading strategy.

(If you’re interested in more of this analysis, please allow me a shameless plug for the research I write for Waverly Advisors. Our clients cover the full range from individual to institutional, from deeply experienced to developing traders, and I’m very proud of the work we do and the value we offer our clients. If you’d like to see our work, we offer a free, no-obligation trial.)


Adam Grimes has over two decades of experience in the industry as a trader, analyst and system developer. The author of a best-selling trading book, he has traded for his own account, for a top prop firm, and spent several years at the New York Mercantile Exchange. He focuses on the intersection of quantitative analysis and discretionary trading, and has a talent for teaching and helping traders find their own way in the market.

This Post Has 4 Comments

  1. Ryan

    Adam, do you anticipate the fast line hook for your entry or are you waiting for confirmation on the bar close?

    1. Adam Grimes

      I think if you are going to use the hook (you don’t have to do so) it makes sense to wait until close. Otherwise, you have a very difficult system to backtest because of vanishing intrabar signals.

  2. Tim Palmer

    Would you be able to elaborate on how you would perhaps manage a trade like this? For me this is one of the hardest parts of trading- determining where a trade is wrong even if it hasn’t hit my initial stop yet and how and when to tighten stops. Are you still holding through the consolidation that has developed? I understand that there is not one right answer but some insight into how you think about managing trades once entered would be very interesting.

    Thanks again for all you do.


    1. Adam Grimes

      Generally speaking I will tighten stops pretty quickly, even if the trade isn’t moving. This is effectively a type of time stop, but there’s always a tradeoff–you will have a lower win ratio this way.

      I will try to write more soon on trade management. I think I did a podcast on this too?

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