Finding Stock Trading Catalysts

  • Post category:Lessons
  • Reading time:5 mins read
Get Email Alerts and Follow Us:

Folks, finding a catalyst that can power a stock or an entire sector higher is the key to killer profits. Catalysts are more important than being able to read a chart or a financial statement.

You can be the best technical chartist in the world but still go broke in the stock market. You can have a Harvard MBA and know how to read financial statements like the back of your hand and still get b*tch slapped and lose all your money to other traders in the stock market. However, if you know how to spot a catalyst and position early, you can make a fortune in the market and know very little about how to read charts and financial statements.

Most people go from news story, to catalyst. They hear something in the news, then think what stocks could benefit from that news. That’s an impossible task because you can’t possibly think of all the stocks that could benefit from a breaking news story. Instead, go the opposite direction. Use a stock screener to look at stocks first, then go backwards and search for an event in the news. Look for several stocks within the same sector and industry to confirm the catalyst.

The stocks you really want to target for explosive gains are stocks with a market cap of under $300 million. These are called small cap stocks. You can also do this with OTCBB stocks.

Frequently Asked Questions about Finding Stock Trading Catalysts

How often do shorts have to cover?

There is no rule or law that governs when a short seller has to cover his position. Just like there is no rule or law that governs when someone must sell and close out a long position.

Sometimes traders confuse the short interest “days to cover” to mean the number of days a short sellers has before he must close the position. The days to cover metric just takes the average daily volume traded in a stock, and the number of shares short, and calculates how many days worth of trading the short interest is.

For example: if company ABC has 1000 shares outstanding, and 10% of the float is short, that means 100 shares are short. If the average daily volume is 20 shares a day, then the days to cover metric is 5.

Keep in mind that a short sale is a transaction in which shares of a company are borrowed by an investor and sold on the market. The investor is required to return these shares to the lender at some point in the future. The lender of the shares has the right to request that the shares be returned at any time, with minimal notice. In this event, the short seller is required to return the shares to the lender regardless of whether it causes the investor a gain or a loss on his or her trade. But this rarely ever happens as most lenders are large brokerage firms with plenty of stock available for investors to borrow (short).

How do you know when short sellers are going to cover?

Nobody knows exactly when short sellers are going to cover. However, ask yourself the opposite question: How do you know when longs are going to take profits? You look at price action and chart patterns. If a stock spikes upward too far, too fast, it’s a good bet the stock is going to pullback from profit taking. Right? It’s the same logic but reversed for short sellers. If a stock spikes downward too far, too fast, it’s a good bet the stock is going to bounce as short sellers cover their positions for profit.

Most chart patterns do ‘V’ bottom bounces. This suggests that short sellers don’t like being in short positions any longer than they have to. Interest is charged short sellers because they are borrowing stock from their broker, so time is generally not on a short sellers side. Furthermore, over the last 80+ years, the stock market is in an uptrend 70% of the time, and a downtrend 30% of the time. This statistic is why most traders make the majority of their money on the long side and not on the short side of the trade.

The other thing that is stacked against short sellers is that short positions must be reported for regulatory purposes. That information is made public by groups like the NASDAQ with about a 2 week time delay. What that means is that because short sellers must buy a stock back to cover their short positions, you can know what future buy side demand from short covering is likely to be. In a stock with 20% or more of the float short, with more than 10 days to cover, what happens is that the exit for short sellers can get crowded. In the event of an earnings surprise, new business, or even a buy-out offer, if all the shorts race to cover at the same time, a whopping 20% of the float is going to turn into buy orders quickly. This short covering causes a ‘V’ bottom bounce which swing traders work to exploit for profit.

Get Email Alerts and Follow Us: