Many traders struggle to know where to enter and exit trades.
Most can easily identify basic support and resistance levels.
But they never know IF those levels will work.
It always feels like there is some piece missing from the equation.
This problem vexed Roland Wolf for a long time.
As a long-biased trader, he likes to dip buy.
However, he wanted something beyond Level 2 data to help him identify key support levels.
That’s when he watched a video from fellow millionaire trader Tim Grittani.
Ironically, the video talked about short sellers.
And that’s when the lightbulb turned on.
As he spoke to traders at our conference this year, he explained how his mindset changed.
You see, none of us are individually big traders, even ones with millions of dollars.
Instead, we need to think about things in the aggregate, asking questions like:
- Are there shorts?
- Where would they get squeezed?
- Where would short sellers take profit?
Roland answered these questions, explaining that he works in harmony with short-sellers.
That change in his mindset helped him become a profitable long-biased trader.
Unfortunately, this is an afterthought for most traders who focus on their trades instead.
The good news is that these three simple questions can help any trader identify important price levels.
I want to show you how to apply these to recent charts to see how this works in a practical setting.
Are There Shorts?
A stock’s price often determines whether traders will short the ticker.
You see, margin rules are different for stocks priced below $5.00.
If you’re not familiar with the concept, short sellers borrow stocks from their broker and sell them in the open market.
They try to buy them back at a lower price, sell it back to the broker, and profit off the difference.
Since a stock could go to infinity in theory, brokers require short sellers to have a margin account.
This allows traders to borrow funds and use leverage on their trades.
Normally, traders can use up to 4x the capital in their account.
However, when a stock is $5.00 or below, a trader must put up a minimum of $2.50 per share in capital.
If a stock costs $5.00, you have to put up $2.50, which gives you 2x leverage.
At $2.50, your leverage is 1x.
If a stock is below $2.50, you still need to put up $2.50.
Say you want to short 1,000 shares of a stock that costs $0.10 per share.
You would need $2,500 in capital to short the stock.
Consequently, traders won’t short stocks below $1.00.
Look at a chart of Nine Energy Services Inc. (NYSE: NINE), a recent runner that went from $2.50 to $11.00.
We need to answer the question: Are there short sellers?
Almost certainly, yes.
This stock jumped almost 500% in a matter of weeks.
Short sellers love to try and pick off the top.
And once it got over $5.00, the special short seller margin rules stopped applying.
But there’s one important point to mention.
Short sellers need volume.
Without enough volume, as in millions of shares, they won’t be able to enter a position.
Where Would They Get Squeezed?
This is a pretty easy question to answer.
All you have to do is think about this question…
If I were a short seller, where would I put my stop?
Don’t think too hard on this one because it should be pretty obvious.
When a stock goes Supernova, short sellers like to use important highs as their stop loss.
With NINE, you don’t get a cleaner high than $11.00.
Now, if the stock were still in an uptrend, you might use the high of the day as the squeeze spot.
Where Would Short Sellers Take Profit?
But let’s look at NINE and see if we can’t figure it out.
Keep in mind, we doing this so we can find a good support level to buy the stock for a bounce.
The high was $11.00.
The stock started its run just below $2.50.
Half way would be $6.75.
That would make logical sense as a potential spot.
But let’s say I wanted to be even more conservative.
The high of the trading range right before the latest run was around $4.28.
If I was a short-seller holding a trailer, that would probably be the final spot where I’d take profit.
So, if the stock came down to that level, there’s a very good chance it would bounce from there so long as it comes in quickly.
If a stock edged lower over time and just faded into that level, most short sellers wouldn’t have the patience to stay with the trade.
I know this might seem impossible at first.