Going short

I think the market keeps correcting in the next 2 months.  Maybe 6-8 months.  Economic growth is slowing, the Fed is tightening, and the market internals are crap.  Should be at least as bad as Dec 2018.  Right now its like the market has run off a cliff, but hasn't dropped.

I added some shorts on Friday's open, which are now nicely profitable.  This market cycle is my first attempt at shorting.  This piece describes how I'm trying to do it.  A value investor trying to turn into a short seller.

How do professionals short?  Risk managing shorts is tough.

John Hempton at Bronte Capital described how they do it as fundamental long-term investors.  They search for fraud.  Like companies with mysteriously high margins, or where the products/numbers don't make sense in the real world, or ones run by previously fraudsters.  These stocks can go up several times on the way to zero - sometimes ten times  - so they manage risk with a lot of small positions.  Around 50-200 positions for a short book thats 50% of their longs.  They avoid heavily shorted stocks.  And continuously monitor positions to avoid gamma squeezes.  Its not possible for an individual investor.

Short-term traders risk manage by watching the screen all day, recognising when the position starts acting against them, and cutting their losses quickly.  They might be successful with a 2-to-1 failure rate, with failures typically cut a few hours after being placed, while successful shorts run for days.  I don't know how to trade, and I'm asleep most US market hours, so I can't do this.

Why am I going short?

I don't wanna sell my stocks because:

• We are living off the dividends (my salary gets added to my portfolio every month).
• Inflation should drop from 8% to maybe 3-4% this quarter.  Holding cash with 3-4% inflation, is still losing.
• The commodity producers I'm holding (oil, copper & palm oil) have not yet fallen with the market.  Some have wobbled a bit.  These stocks probably get hammered in the next few months.  But they might not.  I'm still bullish on commodities/inflation long term, selling them now to buy back later is a risk.  For oil, for example, there are good reasons why it may go higher in the next few months (starts at 10:22), 

So I'm shorting to hedge my longs.  So I can stay long for longer.

How am I doing it? 

First, I'm using Hedgeye's risk range and following The Macro Show to determine what and when to short.  Basically, they look at what has historically gone down in the current economic conditions, confirm that is it going down now, then look for times it is overbought to short it.  They trade a lot, far more frequently than I can, so I have to adapt their process for my needs.

So I've got to be more of a trader when shorting.  When I buy something, there are hundreds of reasons: the company has a moat, its undervalued, or management is god-like.  When I short, its because the price is going down.

Second, I'm only shorting ETFs or funds: index, country or sector funds.  Hedgeye's individual stock shorts are often too quick for me, sometimes covering on the same day.  And individual stocks can move too fast: better than expected (or less worse) earnings results can make them gap up.  Or maybe Musk decides to buy them over.

Third: I hope to hold these shorts for a few months, or until the market turns.  Won't be doing much trading in and out, since I'm not a good trader, even when I'm awake.

The main lesson I've learned is how fierce bear market rallies can be.  I shorted Q's in March.  QQQ had been dropping a while and was overbought, it was a good day to enter the short.  But it moved against me:

It was a 2% position, which was too big for a volatile instrument like QQQ.  Should have started with a 1/2 percent or 1% position, then added to it if it moved against me.  Need to keep my short positions smaller half the size of my longs, and remember that bear market rallies can rip your face off.

Right now my positions are:

• 98% invested in stocks (....the 2% cash is my last few month's salary).  Around 80% in low beta dividend payers, the remainder are commodity producers.
• 10% invested in Gold.  Yes, on margin.  Gold should go up when the market falls.  
• Offset by a total of -8.5% short positions.  Q's, Russel and Junk Bonds. Half these were added Friday.   May add more country shorts, eg: Korea, HK, Europe.

This piece is all I know about shorting.  If you've got this far, you'll realise I don't know much.  Its more a learning experience and probably too small to be a serious hedge.  Maybe it gives me some extra pocket money to buy more shares after the market has crashed.