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)…….
- Most Stocks & Markets Are Long Centric.
Indeed, they are. However, this means very little to an investor who is going through a pro-longed bear market or a significant decline in one of his or her securities. For instance, this idea becomes meaningless to someone who was fully invested in 1929. As by 1932 that portfolio had lost 90% of its value. Or to someone who had to endure a 16 year bear market between 1966 and 1982. Or to someone who has seen miniscule results since the 2000 top. As outlined earlier.
Once more, short positions should not be viewed as a long-term investment. They should be viewed in the light of hedging and maximizing returns when the market is not cooperating with its overall “long centric” premise. As was outlined and explained in one of my earlier books “Timed Value”, the stock market tends to move in 17-18 year alternating Bull/Bear market phases. And while it would make perfect sense to remain fully invested and 100% long during bull markets, it would make very little sense to continue on with the same strategy in a bear market. After all, doing so would lead only to frustration and losses. Short selling helps us avoid both problems in the proper market environment.
- Additional costs associated with taking a short position.
Depending on your broker, the transactional costs associated with taking a short position are typically equal to you taking a long position. However, you do tend to pay more though margin interest and dividend payments. For instance, if the short position begins to move against you, money will be removed from your cash balance and into your margin account. If you do not have enough cash to cover the losses you begin to borrow on margin, thereby accruing margin interest charges. Otherwise, if you do have enough cash in your account to cover your short losses (if any), no margin interest costs will be inquired.
When it comes to dividend payments you are responsible for paying underlying stock’s dividend if you are holding the stock short ex-dividend date. Without getting into the details of the entire process, you must pay the dividend on the underlying security if 1. The underlying security has a dividend associated with it and 2. You are holding this security short on ex-dividend date. At times, such costs can be significant.
Yet, for the most part, both costs can be mitigated or largely eliminated when short selling is approached in an appropriate fashion. When it comes to margin interest, simply maintain a cash balance big enough to cover your short positions and any losses that you might inquire if the positions move against you. That way your margin account is never triggered and no interest charges occur. In terms of dividends, either avoid shorting stocks that pay dividends or get out of your position before the ex-dividend date is triggered. Plus, unless you are shorting a specific stock for company specific reasons, you shouldn’t be shorting stocks that pay dividends. Simply choose another non dividend paying stock in the same industry and short that one. And if you are to do both, the costs of going short become equal to the costs of going long.
In summary and as the points above show, when short selling is approached in an appropriate way, the risks associated with the practice are reduced to a bare minimum. And while the overall risk profile might be slightly higher than going long, when executed properly, going short is not nearly as risky as the investment industry makes it out to be. If anything, the practice plays a crucial part in a powerful investment approach discussed bellow.
To be continued next week.
It’s Hard To Be A Bear When Everyone Is Bullish. Part 5 Google