Is It Too Late To Go Short?

Reader Ray had some interesting observations about the market, very similar to what many others have voiced. Here’s what he had to say:

I feel I am like most investors and most of us are very conflicted in a bear market, as I, most of us feel it will end without being properly positioned for the next up move. (LOOK OUT– EMOTIONS AT HAND) Most of us (like most humans) are positive, optimistic long only investors, and this bear market is difficult to be patient with.

With that said, it has also been demonstrated that you can have some very violent moves to the upside in a bear that appear to leave you in neutral as the market advances only to suck you in at the end of the move with another leg to the downside (financials from Jan 12 to end of the quarter– THEN SMASHED).

Even your last buy was met with a whipsaw, but to your credit, out again before the major damage was done. The hardest thing to do is take a loss for me and therefore mutual funds have offered the best risk adjusted vehicle. I have learned this after some devastating losses in individual stocks– tech heavy in 2000, fooled by dividends i.e. financials or any other excuse to stay in a loser.

My lament is that I was not able to recognize this bear earlier and position myself in those sectors that were deteriorating and take advantage of this wonderful opportunity to add another risk adjusted strategy—-short.

As you can tell by my comment that I am not short, but I am majority cash. Is it too late? My feeling is that a DOW 14,265 now 11,000 it probably is. The real question is how did I miss the opportunity to take advantage of that 3000 point move to the downside that seems so obvious (in hindsight) in retail, finance, homebuilders etc.

I also agree with your point that this bear could be much longer and much more severe because of such a strong move from the beginning of 2003. I state that because I am still wondering if it is too late to position a short?

Great work to get us in cash so soon after that last up signal.

My view is that I’d rather be a little late to the party than too early. I have received some reader email who admitted having shorted the markets heavily a couple of months ago, only to be caught on the wrong side during the rebound rally.

When the domestic Trend Tracking Index (TTI) breaks below its trend line into bear market territory, it’s a buy signal similar to the TTI breaking above it. The only difference is that you’re buying inverse funds/ETFs which gain as the markets fall.

You still need to apply the same discipline by allocating an amount to short funds that you are comfortable with. That could mean 10 – 20% of portfolio value, or more, if you have a higher risk tolerance. But most importantly, you still need to apply the same stop loss discipline that you use on the long side.

So, is it too late to initiate new short positions now? Looking at the big long-term picture, I see a lot more downside potential. However, that does not mean that there won’t be dead cat bounces, which can stop you out quickly.

As always, your emotional makeup should determine whether shorting the market is for you. As I noted recently in “Is Short Selling Worth It?” long-term the effects of short-selling on your portfolio may not be what you would expect.