Continuation from Friday…...(What You Ought To Know About Short Selling)
In terms of your short stocks appreciating over time….if you apply proper trading rules, this shouldn’t be a problem at all. Just as you should have trailing stop losses with all of your long positions, you should exercise the same discipline when going short. If the marker proceeds to move against your short position, the stop loss will take you out when the time is right. Either realizing gains or limiting losses in the process. Just as it would if you where holding a long position.
In conclusion, outside of seldom “God Event” occurrences in certain stocks, equities that you shouldn’t be shorting to begin with, short selling is about just as risky as going long when proper investment rules are applied.
- The Maximum Gain Is Only 100%.
It is true, the maximum gain you can achieve when going short is just 100%. Yet, that type of a return is unusual as well. For that to happen, the underlying stock price must hit zero. An occurrence most typically associated with the underlying business filing for a bankruptcy or otherwise being delisted from the exchange.
The financial crisis of 2008 presents us with a perfect opportunity to illustrate just that. In the darkest days of summer of 2008, stock prices of many of the subprime lenders collapsed in a matter of 2-3 weeks. In many instances going from $50-60 share to $1-2 a share before filing for a bankruptcy protection and being delisted from the exchanges. A rare occurrence, indeed.
And while your gains are limited to 100%, it is not a bad thing when you consider what our primary objective in this case is. Remember, we are not trying to identify stocks that will appreciate 1,000% or more over the next 5 years. We are simply trying to protect our existing long positions while generating extra returns on the downside. Essentially, we are trying to minimize risk while moving with the overall market or the underlying security. Short selling allows us to do just that.
- 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 had 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 since 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.
To Be Continued Tomorrow…….
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