There are countless stocks that their share price looked to be too high based on their P/E ratios, but the price went much higher in the months ahead.
As a matter of fact, there are many stocks that turn out top be really big winners on the short side, even though they have low P/E's.
So the lesson is: fundamental overvaluation is NOT the way to uncover a short sale even though it is the most common method of stock market players.
* Don't sell short because the stock price has advanced too far.
If you like Russian Roulette, this is your kind of game. Stocks that go high, can indeed continue to go higher. Use your technical analysis tools to analyze the situation first.
* Don't sell a Sucker Short; a stock that everyone agrees must fall.
These are a combination of a big run in share price, a high P/E and lots of media attention. In addition, it has a very large short interest (the number of shares of a stock that are currently sold short).
Theses "too-obvious" stocks often have a short interest of five or more times the average daily trading volume. When a stock starts to climb with this high short interest, short sellers scramble over each other to buy back the stock to cover their shorts, which in turn pushes the share price even higher!
* Don't sell a stock that trades thinly.
This means a stock that has little trading volume each day, like a few hundred shares. When you cover your short, your buying will cause the price to rise, and it doesn't take much buying to panic the other shorts, causing a short squeeze, thus driving the price higher.
* Don't sell short a stock in a strong Industry Group
If overall, most of the stocks in the Industry Group it is in are all strong, be very mindful and cautious before selling short.
* Don't sell short without first protecting yourself with a stop loss order.