Bobcor:
It's for certain that I am far from an expert at shorting, but I have always viewed stocks as two way streets.
Previous to the arrival of this mania, my approach to the market was to continually hunt for two kinds of companies,.... tech juniors and/or start-ups that looked like they might grow, as well as companies that were priced for growth but were heading for trouble for lack of sales. Long the former, short the latter. Over the years, both provided solid returns.
Unfortunately, it took this dumb bunny far too long to recognize the arrival of a full-blown mania. It was an expensive lesson. Shorting in a mania is a very different and much more dangerous game than is the case in a more rational environment.
While it may be accurate that there are plenty of fools in the market, it's been my observation that they are few compared with the guys and gals who are much smarter than I (my early market experiences made it apparent that too frequently I was that "greater fool" others relied on). Early expensive lessons quickly confirmed for me that a thorough understanding of the fundamentals of a contemplated investment, at least improved the odds in my favour. Usually, having the fundamentals right leads to more wins than losses, but again, this is not the case in a mania.
Once one recognizes that a mania is underway, the choices become difficult, particularly if one knows how all past manias have ended. Does one continue to go long, believing that as the end approaches, enough signs will appear to cause one to quickly exit? Or perhaps just go to cash and stay on the sidelines until the crash is past? At this end, insufficient brain power precluded the former, while greed eliminated the latter. For better or for worse, until the mania ends, Vaderian strategy dominates my thinking. (g)
By definition, successful shorting in a mania is difficult, therefore modified strategies must be employed. The good news is that the mania provides plenty of targets. Additionally, the longer it endures, the closer the eventual end and the greater the inevitable fall. The bad news is that deteriorating fundamentals tend to be ignored until they are overwhelmingly nasty, and there is no telling when the final straw that breaks a particular camel's back is at hand.
During this enduring tulip, several non-standard (at least to me) approaches have improved achieved short side results. Here are a few of them.
- Michael Burke's two part strategy has been shamelessly adopted (and adapted), primarily because it is an ideal way to tackle the short side in a mania. Michael advocates a 90%-10% strategy with respect to allocation. The numbers aren't as important as the strategy, which is to have only a small percentage of one's resources exposed to the high risk part of the game. The advantages of this approach, especially with respect to shorting, should be obvious. Michael also advocates the use of put options rather than the establishment of actual short positions, which makes much sense to me. Occasionally, the premiums are just too large to allow this, but the leverage, the defined and limited exposure, and the reduction of sleepless nights are big plusses. I have also found his "thirds" entry approach to be incredibly valuable.
- Personally, I prefer deep-out-of-the-money puts with plenty of time. This keeps the cost of maintaining exposure to a given situation quite low, even over an extended period of time. When a target blows up, the pay-off extends well down the strike price curve.
- Not only must the fundamentals be truly ugly (why mess with good targets when great targets are available), but the debt load must be overwhelming. Massive debt levels are relentless entities that grind companies into the dirt. Bloated debt is a short's best friend.
- "Mortally wounded" stocks provide the best risk/reward ratio in a mania for me. Bankruptcy must be either actually underway, or at least very close at hand. Bankruptcy usually ends with the debtholders getting everything and the share holders getting nothing. There is often less risk in shorting a company that has already fallen from $25 to $5 on its way to bankruptcy than if one had shorted it at $25. Percentage gain over time is what counts.
- It is mandatory that one remains up to date with respect to the ongoing situation. Clear any short positions when this is not possible.
While I personally view charts as similar to goat entrails, I still keep track of what they are telling the vast horde of market players who rely on them. As you note, it adds to the odds when the charts are on your side.
- If short, set and rigidly maintain a specific price where one will clear the position and take losses if the stock price moves Northward.
- If a shorted stock experiences a "bad hair"day and gets whacked, take profits on at least a good part of the position. "Buy-the-Dippers" are likely to rebound the stock price.
- Even when a stock is "mortally wounded", initially, only a 1/3rd position is taken. Stocks that are tracking through bankruptcy proceedings are extremely volatile and can double or triple in a day. Usually this is as a result of hype or rumour, and the "spike" typically dies away a few days later. A second "third", positioned during such "spikes", can be extremely rewarding, and over a very short time frame.
Best, Earlie |
