Sunday, June 29, 2008

Time To Short Stocks

According to Dow Hits Bear-Market Territory, Signaling Woe For Economy in The Wall Street Journal, June 28-29, 2008, the Dow has fallen 20.2% from it's October, 2007 high. The article expects that the market has further to go before bottoming.

I agree.

As a result, I will be modifying my trading strategy to include shorting stocks. For reference, going short means selling a stock and then buying it back in the future, hopefully for a lower price. If the stock should go down, one makes a profit. If the stock rises, one loses money. This is the opposite of going long, which means buying a stock and selling in the future, hopefully for a higher price.

Here is how I am going to short stocks:

  • Buy mutual funds or ETFs that short. Currently, I own the Prudent Bear (BEARX), which engages in shorting individual stocks, owning commodity stocks or treasuries. I first bought the Prudent Bear in the last bear market in 2002. I recently purchased some more in the last three months.

    Since 2002, a number of inverse ETFs have been created that essentially enable an investor to short the market or a specific sector. I am not a big fan of shorting the overall market, since I believe the stock market has a long term upward trend. However, I am considering the Short Financials (SEF) or the UltraShort Financials (SKF) as a potential sector short.

  • Short individual stocks. In a bear market, hundreds of stocks will be setting new lows every day. While almost all stocks will fall, the worst business will fall even faster in a bear market.

    As an initial screen, I have looked at the stocks ranked 5 in Value Line. These stocks are expected to have the lowest return in the next year. In a bear market, that typically means a negative return.

    For perspective, I do not short bubble stocks that are going up, e.g. housing in 04/05 or energy in 07/08. I typically short stocks that are already in a downward trend. Therefore, I will also look at stocks with new lows as potential short candidates.

    Finally, I expect further declines in sectors such as the financials, retail, and perhaps consumer non-essentials.

    One example of stock I am considering for shorting is Las Vegas Sands (LVS). The casino industry is an example of a consumer non-essential that is has been hit by consumers spending less, on top of being in a bad housing market. Its 52 week high is $147.76 and, this past Friday, it hit a new low and closed at $47.10.

  • Although I've increased my cash position, I don't plan to sell off all my long positions at this point. I optimistically still believe market will be up in the long term, e.g. 5 to 10 years. I am only shorting stocks to offset losses from my long positions in the short term.

    Disclosure: At time of publication, I only own shares of The Prudent Bear Fund.

    For more on New Beginnings, check back every Sunday for a another segment.

    This is not financial or investment advice. Please consult a professional advisor.

    Copyright © 2008 Achievement Catalyst, LLC


    investmentplayground said...

    SS - I'm surprised that you'd recommend shorting stocks to your readers!

    It has to be noted that shorting stocks is one of the riskiest things an investor can do. This market is volatile. Just three weeks ago we crossed 13000, now we're down to 11400 in the Dow. Your losses are limitless when shorting stocks. If you posted this a year ago - then I'd be more inclined to agree with you. But the markets have already taken a beating. Shorting individual stocks requires ultimate due diligence, which most part time investors don't have. Shorting sectors is tough as well - because chances are that the negative sentiment that you've found is already priced in.

    I think shorting is something that every savvy investor should address - but be extremely careful. How much lower can stocks go? If you can't answer that definitively, don't do it.

    in my humble opinion -

    Super Saver said...

    @ Ali (Investment Playground),

    Thanks for your comment and cautions.

    To clarify, the post was written only to share my investment thinking and strategies. It was not intended to be a recommendation. Apologies if the post appeared to be making a recommendation.

    Your comment made some very good points about the risks that need to be managed with shorting. I do agree that shorting should only be done by experienced traders as I wrote in Shorting Stocks - For Experienced Traders Only. Definitely, shorting is not for novices.

    If I do take a short position, I will do weekly updates on Monday. Hopefully, the results will show I had a good estimate of the market direction :-)

    concierge said...

    Your cautious outlook on the market is justified and the markets are certainly volatile as there are so many unknowns right now. However, all of the doom and gloom (and a risk premium from all of the uncertainty) is already baked into the equity prices so if you buy now you are getting prices that reflect this. A contrarian investor would be thinking that this may be a time to purchase equities.