Explanation: Being a bear while everyone else is bullish is one of the most challenging propositions in investing. For instance, ‘Short selling is an incredibly lonely proposition,’ billionaire hedge fund manager Bill Ackman says. Yet, it can pay off big time if you get your TIMING right. However, since most people, even professional investors are terrified of shorting, I will introduce a quick series about short selling, proper risk management when short selling and the best way to maximize returns. This was to be a part of my never finished book (no time to finish it)…….
So, which investment approach is the best for our newly enlightened investors?
We’ll get to that in a second, but before we do, there is yet another intricacy that you should be aware of. Whether it is the mutual fund industry mantra of buying and holding forever or any of the investment approaches above, they all have one thing in common. Most investment approaches are Long Centric. In other words, most investors invest only in anticipation of rising markets or higher stock prices. Completely disregarding the other half of the equation. That stocks do fall. Sometimes substantially so and sometimes they do so over extended periods of time.
A bear market of 1966 to 1982 gives us a perfect opportunity to see just that. The Dow topped in 1966 at around 1,000. Over the next 16 years the market proceeded to oscillate up and down, yielding negative results and at least three gut wrenching sell offs of 30-50%. When a bear market ended in 1982 most investors had nothing but a 25% loss to show for their efforts. That is, in the best case scenario.
Yet, this devastating loss of time and capital could have been entirely avoided if investors concentrated on both sides of the equation. Long and short. Instead of sitting and waiting for the stocks to appreciate over the long-term, investors should have moved with the market. Going both long and short as the market oscillated during that time.
The problem is, the same mutual fund industrial complex has drilled a certain thought into investor’s minds. That short selling the market or individual stocks is not only inherently more risky, it is darn un-American. In fact, every single time the market sells off or corrects, just as it did in 2000-2002 and 2007-2009, there are loud calls to either curb or outright ban short-selling. Mostly due to the misinformation that short sellers are causing the underlying collapse. In fact, financial medial oftentimes portrays short sellers as outright criminals who should be grouped together with murderers and shipped off to prison. Better yet, Siberia.
The reality couldn’t be further from the truth. In fact, before we move on to the greener pastures let’s take a closer look at short selling and some of the misconceptions associated with it. Understanding the subject matter in greater detail will allow to put together a compelling case for our new investment approach.
Wikipedia defines short selling as a practice of selling securities or other financial instruments that are not currently owned, and subsequently repurchasing them (covering) to exit the transaction. If you are not familiar with the process, it is not as complicated as it sounds. Going short or taking a short position is the exact opposite of going long or purchasing stock in anticipation of a price increase. When you go short you anticipate or you bet on the upcoming price decline. The transaction is initiated when you borrow shares of the underlying stock and immediately sell it in the open market. If your forecast proves accurate you will close the transaction at a later date by repurchasing the stock at a lower price and returning it to its rightful owner. Keeping the spread between your entry and exit points. And while it might sound complicated, the entire transaction can be done with one click. Just as if you were going long.
Now, the financial industry has done a fairly good job brainwashing the public into believing that short selling is inherently more risky than going long. Why? For a few primary reasons, when short selling is compared to taking a long position. First, the potential loss on a short sale is theoretically unlimited as compared to a 100% maximum loss when going long. Second, the maximum gain is limited to 100% while your maximum gain on going long is theoretically unlimited. Third, most markets and individual stocks are naturally long centric, increasing in value over time. Finally, there are extra costs associated with taking a short position.
Let’s now take a closer look at each one of these points to see if they hold up to scrutiny.
To Be Continued Tomorrow……
It’s Hard To Be A Bear When Everyone Is Bullish. Part 3 Google