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Episode 597: That Time We Shorted America, Part One

I'm posting this to @Stock Picking Discussion because it's informative but woefully wrong due to omissions in reporting about what #Shorting #Stocks is all about. They are #Mathematically correct when they talk about having no theoretical maximum amount you can lose if things go the wrong way. They are terribly wrong in reporting as if there isn't a responsible reason for shorting securities. If you only listen to the embedded podcast below, you would wrongly assume that shorting is just gambling and dangerous gambling at that. That can be true but is not normally the case.

The #Long Buy of securities is simple, you hand somebody money and they give you a proportional right of ownership in a specific company. A Long Sale is merely the opposite.

A #Short Sale is when you sell shares that you don't own; this is possible if the finance company you trade through has a set of their own shares of the company you want to short. On the books, your account gets credited the cash from the sale to do with what you like, but your account is debited the quantity of shares you borrowed for the short-sale. You can't return the cash to settle the account, you must return the shares in their full quantity to cover the account.

As a metaphor, imagine your nearest neighbor owns a Ford Fiesta. Imagine you also think that something is going to cause the prices of all Ford Fiesta's to go down in the future. You short-sell their Ford Fiesta now and collect $10,000.00 then tomorrow you look on Craigslist or eBay Automotive or some newspaper want ad's and find one with the same color, options, condition, and mileage as the one you shorted for the price of $9,826.00. That one is what you will Short Buy to cover the borrowed one from your neighbor's house. You profited $174.00 on the decision. The reason the metaphor works is all shares of a specific class for a company are identical.

In that example, suppose you were wrong about the price going down. Suppose some news made them the best car to own on Earth! You might think, I'll wait it out. True, you will only lose money if you buy it back while it's high. While you were waiting, a lot of collectors start buying them and the pricing bids up by the minute. Do you wait even longer? What if the price got to $500,000.00? At what time do you give up hope and take the "L" on the trade? This is why there is no upper bound to how much you can lose on a short-sale. Obviously there's a slim chance that prices will run away like that, or that you wouldn't be able to wait till things got better, but if you have looked at enough stock charts, you will see steep cliffs that have happened in their history; violent price shifts are not rare in the market. They accurately point out that the long-run trend of the market is upwards. They were wrong to not state that most businesses do not last and their long term value goes to zero, although more new entrants appear than go out of business. That's all I want to say about speculative short trades.

If you know something about M.P.T., which in short is building a #LowRisk #HighReturn #Portfolio of stocks and bonds, you would know that you have to buy shares based on a specific set of proportions in order to have the ups-and-downs of your total investment smooth out. Sometimes the calculation to set the proportions tells you to short securities that you want in your portfolio. This is not speculation, it's #RiskManagement. Many money managers talk about #BuyAndHold versus #ActiveManagement. The way you short-sell in #MPT is a type of short-and-wait; it's a long-term short-sale akin to buy-and-hold. The reason this happens is the calculation takes into account the way every pair of securities in your set correlates over time. The #Statistics have determined that to reduce the ups-and-downs in your overall value the shorted security will act as a shock absorber to the total investment.


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