Question for Shorts

[nodoodahs]

A question for Henry and for those reading who participate in shorting stocks (actually I have several but I will settle for one line of questioning).

Do you actually short, or do you use puts?

If you actually short, have you ever been forced to cover? No, I don't mean you voluntarily covered or conceded; I mean actually physically forced to cover because the lender of the stock needed it returned. Does that ever happen? I know it could, but in your experience, does it ever?

Other than the lender of the stock recalling it, what is to keep one from holding a short position indefinitely?

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I haven’t seen a beatin’ like that since somebody stuck a banana in my pants and turned a monkey loose.

[nodoodahs]

No, I'm not about to go short, I'm investigating a possibility ... currently I think we're in for a wacky ride, little chance of a boom but little chance of a major bust.

Elaborating on the model: IMHO monetary policy instability is a major cause of boom/bust. I get this from ABCT but where they have their own definition of "money" (very close to MZM) I have found most success studying M3. I started by defining a "crash" as any period where the S&P total return was -20% or less over a 13 week period from 1983-present. I then looked at M3 changes over the previous 15 months and found a pattern. It's non-linear and I don't think you'd see it if you graphed a time series ... I got all wrapped up in mathematics and tried to express it as a series of formulae. This is a weakness of people in my profession, to which I am not immune. Finally I settled on a screening criteria based on M3 changes and S&P returns over the last 15 months, I evaluate weekly.

My original thought was to switch to cash, but I found it worked better switching to 10 Yr Treasuries. Then I read your post on Google and thought, if I switched 80%-90% to Treasuries on the signal and took the remainder and shorted some good candidates it might work even better.
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I haven’t seen a beatin’ like that since somebody stuck a banana in my pants and turned a monkey loose.

[HenryTo]

Paul,

Your quote is commonly attributed to John M. Keynes. He think he uttered it when he lost his, etc., soon after the 1929 crash.

Bill - care to elaborate on your model? Are you going to go short in stocks pretty soon?

Thanks,

Henry

[nodoodahs]

The psych of holding it I've got. I recognize the problem with going long, other than timing, is that you give the value more time to catch up with the price.

I think I've got a model that will show the 1987, 1998, 2002 crashes. I was planning on using it to switch to bonds for 13-week intervals when the warning kicked in, but it occurs to me I could also switch to shorts.
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I haven’t seen a beatin’ like that since somebody stuck a banana in my pants and turned a monkey loose.

[pcoulter]

Peter123,

I'm not very experienced, but I'd think the only time when you'd be forced to cover would be if you violated margin requirements with your broker. If your broker is large enough and can find shares to borrow you shouldn't have any problems unless the stock is thinly traded. The benefit of buying puts is that the most you can lose is the value of the contract - shorting on the other hand, your losses are theoretically unlimited. The benefit of shorting is that you don't have to be right about the timing, only the direction.

I'd suggest slowly building up your short position - don't enter all at once!

"Markets can remain irrational longer than a rational investor can remain solvent." - Not my quote.

[HenryTo]

Bill,

Speaking of EBAY, please see my post made on January 19th:

http://www.marketthoughts.com/forum/viewtopic.php?t=142

Stock closed at 103.05 that day. I shorted some (not enough) and the next it opened at 83.33. Held it for a couple of weeks and covered at the 70s.

Speaking from experience and from various biographies that I've read, most people lose money from shorting over the long-run. It is hard to pin-point the reason why, but following are some of the things that I think hold true:

1) Most people tend to be too early when it comes to shorting - especially on the basis of a stock being overvalued.

2) The psychology that is required in holding a short position is very tough. There just tend to be more emotions involved given the fact that you can lose much more that you "put in." Most people tend to take very quick profits here.

3) Timing is even more important in shorting and most people have trouble timing longs already.

4) The 80/20 principle. 80% of all your profits are made with 20% of your positions/trades, more or less. The truly great long-term investors make their fortunes from holding great stocks such as Philips Morris and Merck, etc., over the long-run. Your short positions can't really contribute that much to your profits overall unless we have a 1987, 1998, or 2002 crashes but those don't happen very often. You can also pyramid your short position as a stock goes down to zero but this is just plain difficult to do. I don't really know anyone offhand that has had the guts to do that, except for George Soros and Jesse Livermore.

Henry

[Peter123]

Trying to find the top for a stock is a dangerous game. If you tried to do this in the 1990's you would be in for some trouble -- you might be trying for several years! Shorting is also not a "long-term" investment. The markets have a substantial "upside" bias that works against a long-term shorting strategy and allows long-term investors to prosper. If you look at the long bond for instance, it is best to stick with the trend until the market says otherwise. Friday showed a major reversal (rather than a simple pullback) that one may react to. This is being reactive as opposed to attempting to forecast a "top", which in some cases may never happen for years.

[nodoodahs]

Henry,

I'm looking at shorting from my own somewhat off-kilter perspective. I've got some metrics I like for solvency that I've back-tested on several companies, some market instability metrics that work pretty well for the indices, and it occurred to me that if you can tell which stocks to avoid, and when to get out of the market, you might as well make some money on it.

In reading about the various "dangers" of shorting there's quite a bit written regarding "short squeezes" and having to buy and cover. However there's little technical information available about the mechanics, i.e., how often one is actually forced to cover, and the timeframe given if so.

It seems to me (and please correct me if I'm wrong) that the vast majority of covering takes place because of choice - either the speculator lacks the time or the huevos to stick with it when it rallies. Since I invest on a long-range timeframe the first doesn't bother me; and when I think I'm right (which is probably too often) I don't have a problem watching the world line up against me (I have held CVX, NUE, NEU, OSG, VLCCF all through last month - you don't lose money unless you sell).

Example: EBAY was overvalued at $50 in '04 (heck it's overvalued now at $40). Obviously the biggest ROI was to short at the top, but the problem is finding the top. Taking a short when it broke $50 and holding that position would have made money. So do a speculator's choice of timeframe, and need (or ability) to pick a top, move in inverse? Longer time horizon speculators don't need to get near as close to the top, but you have to be able to watch EBAY blow through $60 without covering?
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I haven’t seen a beatin’ like that since somebody stuck a banana in my pants and turned a monkey loose.

[HenryTo]

Bill and Peter123,

No, I haven't had the experience of being forced to cover - although I bet there have been cases of that happening during periods like Fall 1998 and the final blowoff period between October 1999 and March 2000. I never did much shorting during that period of time, although I did buy some puts and went short starting in late January 2000 (eventually moving to a huge short position by March 2000).

I got lucky in early 2000 and timed it pretty well. Also timed the gold bull market pretty well starting in 2001. Nowadays, though, I will either go for a time target or a price/direction target - neither both (which buying puts will involve unless you're long leaps). For example, I am now short the long bond via going short TLT. One can also go short via the 30-year futures contract. I am also pretty confident on the direction (although I am not going for the sky-high interest rate scenario that bears have been looking for for awhile) but I would never try to aim for a specific target within a specific timeframe. There are just too many variables and I am too lousy of a trader to maneuver out of it if I do get into a mess.

Bill, are thinking of doing something speculative?

Henry

[Peter123]

Don't know about the covering part; but remember the golden rule of shorting: Short stocks (or sectors, etc.) that are already on a definitive downtrend (a few lower highs) as a safer bet. Shorting a pullback in an uptrend can be risky. Though I am going to take Henry's advice and short the long bond (am currently long) since as he stated the extreme overbought conditions and major reversal candle mentioned.