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Don’t Short When it Comes to Secular Investing

July 7, 2014

Good morning! Today Troy continues about the investing for beginners series. You can check the previous posts about What are stocks and how to value them, How does Currency Trading Work, How are Currencies Traded, Investing in Commodities, What Fundamentals Affect Commodity Prices, What are ETF’s, What are Options, How are Options’ Prices Structured, Investing for Beginners Part 2 – Different Investment Strategies, When does Buy and Hold not Work, An Unconventional Approach to Buy and Hold, An Unconventional Approach to Buy and Hold Part 2, How the Investment Advisor Game is Played, An Introduction Into “Secular Investing”

Don't Short When it Comes to Secular Investing

Photo Credit: freedigitalphotos.net

In the previous post we covered what you should do in a cyclical bull market. But what do you do (as a secular investor) in a cyclical bear market? Investing in a cyclical bear market is very different from investing in a cyclical bull market.

By the end of a cyclical bull market, you will want to have liquidated all your longs (bullish positions) because the peak is in. Normally, you would go short in order to profit from a market decline if you see that the cyclical bear market is starting.

What Does it Mean to “Go Short”

Normally, buying into an investment is a bullish investment. If the market goes up, you make money. If the market goes down, you lose money.

“Going short”, or “short positions” is exactly the opposite. You’re betting that the market will go down. If the market goes up, you lose money. If the market goes down, you make money.

The concept behind going short is simple. You borrow securities (e.g. stocks) that you don’t own. You sell them at the current price. You buy these securities back in the future at the future price. If the future price is lower than the current price, you just made a profit. If the future price is higher than the current price, you make a loss. Here’s an example.

The current price of Apple is $500 a share. Let’s assume I short 1 Apple stock. If Apple stock falls to $400, I just made a $100 profit (500-400), which is a 20% profit. But if Apple stock rises to $600, I just lost $100 (600-500), which is a 20% loss.

Thus, when you buy (go long) a security, your losses are limited (max. you can lose is 100%), while your gains are potentially unlimited (b/c the stock price can theoretically go to infinity). When you sell (go short) a security, your losses are theoretically unlimited while your gains are limited (if the stock goes to $0, that’s a 100% profit). That’s why a lot of investors don’t like to short stocks – the risk:reward ratio isn’t very attractive.

Shorting is a very different concept. If you buy “long” (bullish) positions, it doesn’t matter if the market goes down. It doesn’t affect your cash positions. You can simply wait (use the time factor) for the market to turn around. But shorting is different. If the market goes against you (goes up), it eats into your cash position. This is known as margin problems. If you have longs and the market declines, all you have to do is wait until the market turns around. This is not true for a short position – you don’t have the luxury of time (waiting for the market to turn around). Here’s an example:

  1. You use 75% of your cash to short Stock A. If the market rises 33% (which eats into your remaining 25% of cash), you’re forced to liquidate your entire short position at the worst price possible.

As you can see, shorting requires your timing to be insanely accurate. Thus, all shorts are essentially just trades – with a time factor involved, shorting and secular investing are incompatible.

Shorts can’t afford time – you can’t wait for the market to turn around in your direction. So what can you do as a secular investor in a cyclical bear market?

Do Nothing

Sorry to break it to you, but in the secular investing strategy, there is nothing you can do in a cyclical bear market to make money. But what you can do is not lose money, which is what happens to most investors in a cyclical bear market. Don’t try to “buy the dips”, because the “dips” often turn into hurricanes that kill all the bullish investors. Instead, all you can do is wait for the market to bottom and wait for the new cyclical bull market to begin.

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Lovely comments

  1. FI Pilgrim says

    July 7, 2014 at 4:20 am

    Patience is such a hard thing to master when it comes to stock investing, but you make a good argument for it here. Thanks Troy!
    FI Pilgrim recently posted…The Worst Job I Have Ever HadMy Profile

  2. Brian @ Luke1428 says

    July 7, 2014 at 8:41 am

    I will never short stocks a) because of the risk and b) because I can’t psychologically bring myself to bet on a stock losing ground. You are hoping for the negative which I can’t bring myself to do.
    Brian @ Luke1428 recently posted…The Final Destination Is Worth the Pain of Starting OverMy Profile

  3. Evans Dube says

    July 7, 2014 at 10:00 am

    The same technical analysis you use to go long in a secular bull market are also usable in a bear market. I see no differenc

  4. Brad @ How To Save Money says

    July 7, 2014 at 2:49 pm

    Patience is a hard thing to master when you are investing. While you are sitting on the sidelines you are earning no money. Of course, you aren’t losing any either. I have never mastered the art of patience, which is perhaps why I have done so poorly in the market.
    Brad @ How To Save Money recently posted…Learn to HaggleMy Profile

  5. Marie @ Grad Money Matters says

    July 9, 2014 at 1:58 am

    I do believe in the saying, “Patience is a virtue”. So through waiting, I know you will be doing good in the market.

  6. Derek @ MoneyAhoy says

    July 9, 2014 at 5:21 am

    Good tip Troy. It can be tempting to try and short the market to make a quick buck, but it is very risky and your losses can be infinite!
    Derek @ MoneyAhoy recently posted…My New Book: Stock Market Investing for Newbies is Finally Finished!!!My Profile

  7. Eugene@ ShareInvestorMalaysia says

    July 9, 2014 at 8:11 am

    Me too. I rather buy puts to shorting stocks. But a good article. Thanks for sharing with us.
    Eugene@ ShareInvestorMalaysia recently posted…Understanding Stock Chart PatternsMy Profile

  8. sandhi sudha says

    July 11, 2014 at 4:41 am

    very nice post sir..

  9. fair look cream says

    July 11, 2014 at 4:43 am

    I want such posts to be posted regularly, so that it will be helpful for people.

  10. Forex Trader and Writer @ Orbex says

    July 12, 2014 at 3:16 am

    As a forex trader myself along with financial writer I do know how risky shorting can be. Derivative products need to be handled with caution and therefore an investor should learn a lot about derivative indices otherwise it can eat one’s entire investment amount. As these products are time bound they need to be squared within a specific time before the time ends or it will automatically be squared at the end price, no matter you make a profit or loss. After reading this great post I couldn’t help sharing these trivial but important points. The writer has written this article in a very lucid way. In fact, after reading it I also started thinking that trading through short positions to be very easy. But I thought that it is morally right for me to say these few points as new investors may get tempted to take a short position without having formal training or experience and could end up losing their entire investment. In fact, that’s almost what happened to me when I first put my money in a put option. So, after that incident I’ve taken it on myself as a duty to inform new investors to point it out.

  11. SA'AD says

    March 4, 2018 at 9:19 am

    Well I like what you said,As a junior i want some suggestion. Check my video.Thanks http://ceesty.com/wmofVm

Trackbacks

  1. The One Problem With Contrarian Investing - Reach Financial Independence says:
    December 17, 2014 at 3:32 am

    […] Part 2, How the Investment Advisor Game is Played, An Introduction Into “Secular Investing”, Don’t Short When it Comes to Secular Investing, An Introduction into Trend Following, An Introduction into Technical Indicators, When does […]

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