Stableford Capital Insights

Exercise Caution (and Discipline) with Short Positions

When an investment isn’t performing well and looks to be on a decline, rebalancing your portfolio and opening a short position may be tempting. Maybe you can turn things around and actually make a profit on the investment’s demise. But that thinking shudders when your investment comes back up, as the vast majority do, and you are left owing the difference (plus fees and interest).

Summary of the Short Position

Short selling is an advanced and somewhat risky investment strategy centered around speculation. When an investor speculates that an investment or asset is declining, he or she opens a position by borrowing that same investment (usually from a broker) to sell on the open market, with the goal of buying it back later.The open position created when the investor borrows the investment is referred to as a short position. If the speculation is correct and the investment declines in value, then the investor can buy it back for less. Assets being sold in short positions are referred to as “hot money.”Short sellers profit from an investment’s decline, whereas long-term investors profit from the price going up. Clearly, short selling presents an unusually high risk/reward ratio.

The Short Position Challenge

The exercise below illustrates the difficulty of getting a Short Position “right” on a near-term four-week (20 trading days) basis.Could TODAY be the exception to the historical average? Sure. I’m not going to argue with that. But understand you are taking the other side of methodology with an 80% win rate.The only time periods when the methodology was only about half right were 2007 and Feb. 2020.The key is the Rate of Change in the shares outstanding of SH, PSQ, and RWM, The three Major Index Inverse ETFs.The TSIG Name is Aggressive Short Selling 2 of 3 – 10pct.If the 15-Day Rate of Change of Shares Outstanding in two of the three inverse ETFs goes above 10%, a signal is given.Green is RWM & SH.Yellow is RWM & PSQ.Purple is SH & PSQ.

Why Short Sellers Are Usually Wrong

short position - trader sitting in front of computer screen

Focusing on four weeks after a signal:Since 2010

  • Green is 144 Up & 22 Down (86%)
  • Yellow is 180 Up & 49 Down (77.5%)
  • Purple is 136 Up & 20 Down (87%)

Grand Total: 20 days after the Signal, the market was HIGHER 292 and LOWER only 65 times.Collectively, on a four-week time horizon, Short Sellers get it wrong over 80% of the time.It doesn’t mean the market didn’t go down during the four-week period. If it did go down, by the 20th day it had recovered most of the time (80%).The most recent signals are Yellow, given on February 2 (3826), February 3 (3830), and February 4 (3871). That means that there’s about an 80% chance SPX will be above the listed prices on March 4, 5, and 6.Add the Mean for all signals is 2.3% and that puts SPX above 3915.If I dial up the threshold to 14% from 10%, the collective numbers are 143 & 22.Purple is 63 and 1 since 2010 at 20 days and 55 & 9 at 10 days.

Rotating Assets Rather Than Correcting

Rotating Assets

When the markets fluctuate without a clear reason or direction, as they have been over the last few months, a knee-jerk reaction from risk-averse investors is to cash out, or correct. However, the best way to play the market is to rotate assets to investments in other sectors with lower perceived risk.Referred to as Sector Rotation, this strategy is not just good for the individual investor, it’s actually a key element for markets to maintain longer-term trends. It keeps money flowing within sectors.As money turns to cash rather than other sectors, a correction develops.Watching for rotations from major sectors and sub-sectors can also present opportunities for patient investors. It’s more profitable to look for sustainable developments within sectors rather than spinning your wheels chasing “hot money” or sectors.Keeping a keen eye on how and where money is flowing is a large part of portfolio construction and a key element to Stableford Capital strategies. It’s important to understand risk relative to timelines and markets to make the best money moves for each individual investor.If you are curious about how a short position can affect your investments or how to maximize long positions, contact Stableford Capital at 480.493.2300 or contact us online for a complimentary 15-minute consultation.

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July 8, 2024
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by Stableford Capital