Bear Mountain Bull

One thing traders should recognize is that short selling is not simply the opposite of buying on the long side. Short sales have their own patterns and pitfalls, and probably should be managed differently than long side trades — even in a bear market.

Here’s Bill Fleckenstein:

…one thing that most people probably don’t appreciate about short-selling is that it’s not sufficient to have the right names. Managing the positions and managing the portfolio are perhaps several times more important.

For example, if in 2008 two people — one experienced at short-selling and one a novice — had shorted the same four or five stocks (stocks that ultimately “worked”), their results would likely have been radically different.

Part of that is because as your positions start to work to your advantage on the short side, you must keep up your exposure, and the potential for doing that at the wrong time is quite high (which can lead to big whipsaws).

Further, one tends to make “chunks of returns” in a short period, and that necessitates putting positions on and taking them off. That’s different from the long side, in which management of your positions does not have a huge impact on your return.

To make matters even more dicey, short-sellers must contend with a high degree of noise. Part of it stems from the fact that there are a tremendous number of quantitative trading strategies that appear to make no sense. Another component is the huge amount of Federal Reserve money printing that I keep talking about.

With all the volatility, you must have huge conviction about anything you do, and when you must have that much conviction, it argues for having less exposure. In fact, having 50% exposure these days feels like being fully invested. So, at least from my perspective, the market may be in a no man’s land for a while. And, even though being short may be uninteresting, being long is potentially dangerous as well, because stocks propped up via money printing can still hit air pockets.

Bottom line: In short-selling, you have to get the names right, and then you have to manage them properly. That’s on top of navigating through the market noise and volatility. I offer that up as food for thought, which folks should consider before attempting to make money on the short side.