Ask Colin

I sold Commonwealth Bank short,but its price keeps rising. Am I doing the right thing?

The full question was:

I sold (short) CBA at $40.10. But I got it wrong this time. CBA keeps going up. I had a chance to get out with a small loss at $40.20 for a few hours before buyers moved it and closed the day at 40.50, but I didn’t.

My thinking at the moment is that the up trend is still intact However, I wonder could it be in the last phase of its cycle that is ‘rampant speculation’ where fundamentally nothing significant to justify its current share price. [this was followed by some reasoning based on fundamentals].

From the daily graph, I can see a class A divergence on the RSI and momentum indicators, so I hope it’s a reversal signal. I don’t expect a down trend to form, but that there may be a correction before it resumes its uptrend move that would be enough to allow me to get out with smaller loss. I now look at $41.00 as my exit point.

Several times this week, I think of getting out but it seems my heart and my head don’t agree with each other. Every time I want to get out I just go back at the graph and try to interpret it logically and I just can’t find any reason for it to just keep going up.

The first thing I did when I read your email was to look at the monthly chart of CBA from inception. No matter how I look at, it is in a strong uptrend. My brutal opinion is that you are doing the direct opposite of trying to buy the bottom of a strong downtrend – which is described as trying to catch a falling knife. 

One of the most basic principles of trading is to start your analysis with the big picture and work down to the time frame in which you are trading. The big picture on CBA is, as I said undeniably an uptrend. This presents two opportunities:

Firstly, the low risk approach of trading in the short term in swings that are in the same direction as the major trend.

Secondly, the high risk approach of trying to capture swings counter to the main trend. This is what you seem to be doing in CBA. To do this successfully, you must be faster on your feet and very disciplined, because if you stay too long or get it wrong, the major trend is against you. In the first approach, you have the major trend working with you and it might make you whole if you get it wrong.

In the counter-trend situation, you MUST use stop-losses. You should use them in both approaches, but the danger is so much greater in the second approach.

As for your present situation, if you are being dragged along a road tied by a rope to a runaway horse and you have a knife in your belt, the sooner you cut the rope, the less injury you will sustain.

I suggest that you buy Dr Elder’s books The New Trading for a Living and Come into my Trading Room and study his triple screen method of disciplining yourself to only allow yourself to take trades in the short term that are in the direction of the major trend.