Selling into strength is a trading strategy that involves selling long or short when the price of an investment is rising, but before a reversal occurs. Such a strategy is designed to optimize profit before a reversal occurs in the price of the security by locking in gains or taking a short position.
The investor sells into strength based on the expectation that the price of a security will reverse direction at a future date, and it aims to preserve the gains on an investment. The strategy can result in fewer profits for the trader, but it allows them to lock in the profits earned from the trade before the reversal occurs.
While there is no risk for the trader, selling into strength comes with a risk of opportunity cost that the trader will miss out on profits if the reversal does not occur. Selling into strength is the opposite of buying into weakness, where traders enter into long positions before an anticipated reversal in the price of a security. By buying into weakness, traders expect to capture the upside in the price of the security.
Selling into strength is a trading strategy that involves selling long or short when the price of a security is on the rise.
Selling into strength is considered a conservative strategy for taking profits by preempting an upcoming reversal in the price of a security.
Traders can choose between a lump-sum method for the entire position or averaging in over a period of time.
Understanding Selling Into Strength
Selling into strength is a conservative trading strategy that traders use to avoid the risk of loss by selling out of a long position. Traders entering a short position consider selling into strength an aggressive strategy since they time the market before there is a confirmation of the price reversal. By going against the current trends in anticipation of a downside, the strategy gives traders a greater margin of safety.
For example, a short seller can track the trend of a security’s price as it rises and sell the order before a reversal occurs. If the trader waits until the reversal is confirmed, it will be too late to sell as the price will drop and they will miss easy gains.
Long Position vs. Short Position
A long position is the purchase of a security or security with the expectation that its price will rise, commonly known as a bullish view. Long positions are used when buying options contracts, and a trader can hold a long call or long put option depending on the underlying asset of the options contract.
An investor who expects that the price of an asset will reverse will be long on a put option and still maintain the right to sell the asset at a specified price. Going long on an options contract indicates that the option’s holder owns the underlying asset.
On the other hand, a short position is the sale of a security with the intention of repurchasing it in the near future. Traders take a short position when they anticipate a decline in the price of a security in the short term. When a trader creates a short position, they face a limited potential to earn a profit and an unlimited potential to incur losses.
Strategies for Selling Into Strength
1. Lump-sum trading
Lump-sum trading involves selling the entire long position at the same time. It may also involve purchasing the entire short position. By selling the entire long position or buying a short position, the investor takes a safe approach by preventing losses when the market reverses.
2. Averaging in
The averaging-in strategy involves selling a long position over a period of time to reduce exposure to the risk of losses when a reversal occurs. Averaging in may also involve entering into the entire short position to reduce exposure to losses when a reversal is expected to occur. The strategy helps reduce the extent of loss if the reversal occurs before the trader exits their current position.
Assume that John bought 100 shares of ABC Limited stock post-reverse-split at $50 per share. After a year, ABC Ltd.’s shares are now trading at $70/share, and the price is expected to reverse when it reaches $80. John can sell into strength using the following two options:
John can place a lump sum order to sell the entire holding in ABC Limited at the current price of $70/share. It means that John would get a return of $7,000, hence earning a profit of $2,000 ($7,000 – $5,000).
Selling the entire holding essentially means that John will not participate in further increases in the price and will not collect future dividends. Also, he is protected from any losses that may occur once the reversal happens.
Instead of selling the entire position, John can decide to dispose of part of his position. For example, if John sells 72 shares out of the 100 shares he owns, he will get $5,040. By selling a portion of his shares, John gets his capital back, and the remaining shares will be his profits.
Such an approach ensures that, if the reversal occurs, the capital is protected. If the reversal does not occur, John stands to benefit from the price upside and any future dividends for the remaining portion of shares.
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