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With the Dow Jones Industrial Average
knocking around at an all-time high, interest rates peaking and the
economy slowing a tad, the talk on cocktail party circuit isn’t about
declining stocks and short selling. It’s just the opposite.
Ask anyone you talk to about short
selling and you’re likely to get one of the following: (1) it’s too
hard, (2) you rarely make money, (3) your gains will never taxed as
capital gains and (4) it just goes against the natural order of the way
we should be doing things. Plus, (5) they know somebody who ventured
onto the “short” side and lost big.
Ask them if they ever sold a stock short
and you get a look that says don’t ever look at my sister like that
again look.
Short selling is a strategy that allows
you to profit from a falling market, falling sector or a falling stock.
Shorting is common in virtually every market - options, commodities,
futures and currencies – except stocks.
Why? I don’ really know.
Every investor knows that in order to be
profitable, you must BUY LOW and SELL HIGH. For the short seller, the
same rule applies only in reverse - that is SELL HIGH and BUY LOW.
If you look back in time, some of the
most famous people on Wall Street were known for their short selling
prowess. Names that come readily to mind are people like Jesse
Livermore, Daniel Drew and Joseph Kennedy (yep – that Kennedy – JFK and
Teddy’s daddy).
As for the famous ones today, I’m not
telling and they aren’t either. The people who make their living
shorting stocks full time are held in pretty low esteem by most of the
trading public. Being the litigious society that we are, corporate
chiefs have a tendency to go out of their way to make the “shorts”
miserable.
As a matter of disclosure, I manage a
long/short portfolio and I can be up to 100% long or 100% short. Have I
ever been? No. I’m happy somewhere in the middle. I’m not a
permanent-bear like many, but I do believe that there is a time and
place to be a buyer and a seller of stocks.
So why am I talking
about it?
When you look at all of the reasons why
you shouldn’t be shorting stocks AND the fact that very few people ever
even consider the strategy – the little voice in the back of my head
says that it’s high time to take a hard look at it.
From my perch on the trading turret, I
see a market that is extremely overbought. The indicators that I use to
measure risk are rising across the board. This includes both markets and
individual sectors.
Plus my favorite indicator (the
Bobble-head Indicator) is a flashing yellow light. This indicator, which
is contrary, is something that I developed a few years back. It measures
the attitude of CNBC’s “Talking Heads”. The more positive that they are,
the more skeptical I become.
When is the time to go
short?
For those who follow technical analysis,
the ideal time to short a market, sector or a stock occurs when the
market as a whole is really overbought. Demand has really pushed up the
price level. It doesn’t hurt that Wall Street analysts and the “Talking
Heads” are gushing about the market’s near-term prospects.
As demand lessens, the upward price
action stalls. At this point, everyone who wants to join the party is
“in”. As supply overtakes demand, the price begins to weaken. The chart
pattern reflects this trend shift by rolling over from positive to
negative. The normal course of events is for the price to fall until
supply and demand are once again equal.
Index, Sector or Stock?
Over the years, I’ve shorted indexed,
sectors and individual stocks and my preference is to short indexes or
sectors over individual stocks.
The reason is that it’s easier to do so.
My vehicles of choice are Exchange Traded Funds (ETFs) because of their
size and their liquidity.
I also like to use inverse mutual funds.
These funds are relatively new and allow you to employ a number of
different strategies. Two fund families currently offer inverse funds:
Rydex and Pro Funds. Both are no-load and low-cost. In that they are
mutual funds, they can be bought and sold in retirement accounts such as
IRAs and 401(k)s.
Summary
Short Selling is a viable investment
strategy and when properly used gives you a way to profit when the
markets fall. Selling short isn’t for everyone, but those who take the
time to learn more about it, will find it enticing.
Remember, there’s not a lot of
competition on this side of the market, so in order to be successful,
you have to do your own thinking and let the trades come to you – never
chase a trade. Patience and discipline are virtues and in time, all of
the right trades will come to you.
Start to day learning how to sell stock
shorts so that you can profit tomorrow.
RAC
The Stock Trading Advisor
ABOUT THE AUTHOR: R.A. Christy is a professional stock trader and
recognized authority on
technical analysis. His web sites (http://www.long-short-trader.com
and
http://www.christyinvestments.com) contain a wealth of information,
articles and resources on
everything you'll ever need to know about trading stocks. If you’re
really serious about making
money in the stock market, you need to learn to trade the way the “pros”
do.
Email address to use:
rac@christyinvestments.com
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