The Number One Reason You Should Learn How to Short Stocks

By: Justice_Litle

There are many good reasons to learn how to go short. One of the best ones is maintaining objectivity.

The vast majority of investors will never short a stock (or an index, a commodity or a currency for that matter). A modest contingent will experiment with options and inverse ETFs. But very few will ever take the time and effort to truly explore the “dark side” of financial markets.

That’s a shame, because the dark side has much to recommend it. Not from a perma-bear standpoint, mind you, but an opportunistic one.

From your humble editor’s point of view, the best stance is a flexible stance. Or perhaps think of it like tennis. The ability to go long is like having a good forehand; the ability to go short is like having a good backhand. Can you imagine a tennis player with no backhand? He would be vulnerable in half the positions on the court.

Having the ability to go long or short expands your horizons greatly. It increases the number of opportunities you can take advantage of, which in turn increases your odds of long-run success.

Comparing the Risks

“But shorting [stocks] can be incredibly tough,” some will argue. As if long-side investing is all that much different?

“When you go short your potential risk is unlimited,” the conventional wisdom warns. What an asinine statement! (Technically true, but still asinine. Technically the sun might not come up tomorrow.)

Imagine that XYZ is a dog of a stock with poor earnings quality, a richly valued multiple, a bearish chart, and heavy insider selling – in other words, an ideal short candidate. Is it likely to imagine a stock like this tripling in less than a week? In this age of accounting shenanigans, a sudden drop to zero seems far more probable. Yet nobody goes around saying, “Long-side investing is dangerous because the stock could be a zero.”

And who are these hypothetical people trading without risk points? If I go short at $50 with a risk point at $55 in case I’m wrong, why would it matter if the stock goes to $200? I cut my losses back at $55, remember?

Short-side players are usually very diligent in their use of risk points: “If the position goes against me by X, I am out.” Long side investors, ironically, are much more willing to ride a stock into the dirt.

Yet the short side is consistently portrayed as more risky? Ironic, that.

If I Had a Hammer

There are times when making money on the bearish side of the market is like shooting fish in a barrel. At other times, one will hardly wish to be short stocks at all.

It’s just the same as the long side: Sometimes the money comes flying in through the window. Other times the window is nailed shut. A key task, then, is getting a handle on what type of market environment one is in.

The trouble with only going long is encapsulated in that old saying: “To a man with a hammer, everything looks like a nail.” If bullishness is the auto-default option, then everything looks like a reason to buy.

Learning to go short adds another tool to the toolbox. That doesn’t mean one has to be bearish all the time. It merely enables the option of taking a proactive bearish stance when market conditions call for it.

Maintaining Objectivity

And so now we get round to the top reason for learning how to go short: It helps you maintain objectivity. If you can go both ways with ease, you will be less susceptible to unchecked emotions, confirmation bias or wishful thinking.

A low-to-no-growth economic environment – one that will likely be with us for years – means increased volatility as the average investor struggles. It also means stock valuations can be compressed for months, quarters, or even years at a time.

The way to deal with this is by assessing general conditions. When price to earnings multiples are expanding like an accordion – thus creating visible strength that shows up on the charts – it makes sense to participate in the bullish upside of the market. But when P/E multiples are contracting as investor capital flees – again showing up via bearish primary trends – it make mores sense to “go with the flow,” focusing on potential short candidates setting up for decline.

Publisher's Note: If you want to learn more investment strategies like this, be sure to join us at the Taipan Publishing Group Global Opportunities Summit. Justice will be joining a distinguished team of global financial experts, including all of the Taipan editors and analysts, to show you how you can arm yourself with today’s most sophisticated wealth-protecting and wealth-building “weapons.” You’ll find out how to emerge victorious… instead of becoming the next casualty. And you’ll have a great time doing it.

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Source : http://www.taipanpublishinggroup.com/tpg/taipan-daily/taipan-daily-072310.html

By Justice Litle
http://www.taipanpublishinggroup.com/

Justice Litle is the Editorial Director of Taipan Publishing Group, Editor of Justice Litle’s Macro Trader and Managing Editor to the free investing and trading e-letter Taipan Daily. Justice began his career by pursuing a Ph.D. in literature and philosophy at Oxford University in England, and continued his education at Pulacki University in Olomouc, Czech Republic, and Macquarie University in Sydney, Australia.

Aside from his career in the financial industry, Justice enjoys playing chess and poker; he enjoys scuba diving, snowboarding, hiking and traveling. The Cliffs of Moher in Ireland and Fox Glacier in New Zealand are two of his favorite places in the world, especially for hiking. What he loves most about traveling is the scenery and the friendly locals.

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