Wednesday, December 24, 2008
Short Selling - Scary or Sexy?
To most people short selling is synonymous with gambling...they rather buy and hold battered real estate and infrastructure stocks but will never go short. Risk is something that always exists it is how you manage risk that is paramount. If you close your eyes and cross the road it is risky. A good way to understand this is to look at currencies. If you take the USD EUR pair some people are long on USD which is the same as being short on EUR. Conversely if you are long on EUR it is the same as being short on USD. The idea is to be on the right side of the trend...because at the end of the day the trend is your best friend! Wishing everyone and their families a merry xmas and happy holiday season ahead!
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2 comments:
Hi Hitesh.
You have a good blog running. A few points on short selling.
Short selling is not the inverse of long-buying for a few reasons.
1.) The general direction of earnings for corporates is up, and hence the natural drift for stocks is up.
2.) People are generally conditioned to be bullish and are of a buy only variety. Hence they have a preference for buying rather than selling short. Moreover, as a short seller, you are competing with large, deep-pocketed long-only investors like pension funds, mutual funds and insurance companies, who buy when markets fall.
3.) Liquidity conditions are generally against the short seller as money supply keeps growing and governments try to boost economic growth and stock markets. Such conditions favour the long only buyer.
4.)A stock bought at 10 can go to 100, 1000 or higher. A stock sold short at 10 can at most go to zero. Big money is made on the long side. Gains on the short side are inherently limited (unless you lever up and/or pyramid your positions)
5.) When a long position goes against you, your risk on the position goes down. Say you have a long exposure of 100 out of a total capital of 200 (50% exposure). If the position goes down to 90, your long exposure is now less than 50% (90/190). On the short side however, your exposure goes up if your short position goes up to 110 from 100 (110/190). This is an asymmetrical nature of long vs short.
6.) A losing long position can recover loses if it goes up again. A losing short position may never recover lost money because the stock may never go down to earlier levels again.
7.) Because of the two points above, short sellers are quick to pull the trigger on covering their shorts. As rallies happen, more stops get hit which extends rallies. To avoid your stops getting hit, you might need wider stops. Wider stops mean lower position size for the same amount of risk, which also means lower rewards.
8.) Procedurally, it is easier to be long as compared to short (borrow shares, short, return, etc) stocks. Of course, on the derivatives side, this difference get eliminated.
Ergo, short selling is a game best played by professionals. I have seen many investors getting killed trying to go short. Non-professional should try to keep out of bear markets.
Your blog mentions returns of 30% compounded over 30 years turning 1 million into 2619 million. A post tax return of 30% from trading (pre-tax 45%) might necessitate a higher than normal risk. As you have rightly mentioned, 'There are bold traders and there are old traders, but there are no bold old traders'. Trying to achieve 45% over 30 years could get you large equity swings and very uncomfortable drawdowns.
BTW, both of us share a few things in common. Both are alumni of IIMC (are you 2000 batch passout?), both are full time traders, both are trend followers. But I do not advise people. I lead a quasi retired life trading my own account using long term trends. It would be interesting to know how you got into full time trading and trading advisory business.
Thanks for your comments...I dont agree with some of your views on shorting...what are your contact details...would be great to chat up...
Hitesh
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