Short-selling Part 1 6 comments

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Long-time readers of my blog would know that I have so far been quite resistant to trying to profit from short-selling. But not for moral reasons, for really there is nothing immoral about taking the view that markets will go down and hence backing up that view by selling first before buying up (covering) later. What is immoral is the additional measures the unscrupulous short-seller takes to back up his position by manipulating the market, such as spreading untrue negative rumours (there was a recent case).

I am starting this series of writeups on short-selling for several reasons: firstly, due to increasing possibility of a US recession and contagion to worldwide markets triggering a likely interest in profiting from falling markets (there was already a writeup on shorting in this week's The Edge); secondly, as a learning journey for myself as I develop the material for the writeups and further understand the short-selling process through my articulations; thirdly, for fellow investors/traders to contribute their past short-selling experiences, if any. So please, feel free to give comments or correct me, for I am fresh to short-selling too.

Previously my impression of short-selling was based on pieces of information culled from various market players and from what I had read. More recently, I have spent the last two weeks or so conducting a survey of various shorting instruments available in Singapore's market and will be writing my thoughts on them in subsequent parts. Mainly, I'll be writing about CFDs and SBL accounts, and exploring their characteristics and more personally, my own grouses with them (think this part will be more helpful).

What kind of stocks to short? Perhaps a list of characteristics, culled from this book I have read recently, might be more useful than my personal views, since I haven't shorted (intentionally) before:

1. Emotional rise not founded on reality
2. Rise on increased volume (because people will take profits on the way down)
3. Seems to have stopped rising
4. Has broken down from top area of distribution (characterised by high volume)
5. Has not yet declined >10-15% from secondary peak
6. Very high PE
7. Not thinly-capitalised, not illiquid
8. High downside volatility in past chart action
9. In industries on the downgrade
10. Completed very bearish chart pattern eg. double-top, head-and-shoulders
11. Popular/widely-traded

(extracted from "Bear Market Investing Strategies" by Harry Schultz)

You will notice that a lot of the recommendations are technicals-based. This is probably in recognition of the fact that the horizon of short-sellers is typically short-term. Markets fall much faster than they rise; fear evokes stronger emotions than greed. At the same time, the long-term trend of human development, and hence markets, is upwards. It is probably fatal to sell-and-hold (ie. reverse Warren Buffett).

At the same time, short-sellers, at least in the US, are known to do better research than their long-only opposites. It is probably the siege mentality at work; one needs to be sure, especially when they have the brokerages (typically the bull promoters) lined up against them, and when losses could potentially be unlimited (prices charge to the sky and the short-sellers still need to cover). This is another reason why I'm exploring short-selling; it pays to be in tune with all the bulls and bears and their tools of the trade so that one will not be overly-biased psychologically on the long side.