I never saw a short I didn't like, until now.

Back on November 10th, gullapalli asked me if I was going to short the China markets with Proshares new ETF (FXP) which seeks to be the inverse double of the FTSE/Xinhua China 25 index. I must confess, I didn't know one was about to be offered until after I researched due to gullapalli's question. You see, I consider myself to be the "every man investor". I am a typical non-professional stock trading American, going about my daily business with my wife, job, and financial goals. Though I pour through all kinds of news for my own recreation and betterment, I don't spend my day surrounded with flat screens projecting the latest market movements with the Wall Street Journal in my face as Jim Cramer throws a chair at the wall. I enjoy life, and I am content to know that stress isn't going to cause my heart to explode by the age of 45. I read, research, weigh decisions, and decide. Then I repeat the process, all without losing my head.

That being said, I have been in a relentless search for more information regarding markets, stock price movements, and the like. I have learned a lot from the SLO, and will continue to study and learn well beyond the game. Part of this search for information was spawned from gullapalli's question.

I first needed to know exactly what the FTSE/Xinhua China 25 was. The home page was a great start, and it had a PDF that describes all about it, the companies that comprise it, and the like. The first couple sentences in the PDF sum it up by stating,

"Investors globally use the FTSE/Xinhua China 25 Index to gain exposure to the Hong Kong markets. The Index consists of the 25 largest and most liquid Chinese stocks (Red Chip and H Shares) listed and trading on the Hong Kong Exchange."

The Red Chips are companies incorporated in Hong Kong, and the H Shares are those incorporated in mainland China.

Although I had already made my decision about shorting China even before going to the homepage, it set me off on another round of research for the next several days and will continue into the coming months. Despite my interest in the China markets, they would have no part in my SLO portfolio. The man who "never saw a short he didn't like", wouldn't be shorting China with FXP.

Why?

The reasons are relatively simple. The first one is the fact that there is only about a month left in the game. Most SLO traders are buying and trading like madmen. A month seems like a long time for most. I buy and hold like a madman. With only one month left in the game, I could drop some cash on FXP and hope that China tanks, but there simply isn't enough time for me. Even if the China markets crash tomorrow, I will not regret this decision. I am content in knowing that if China plummets, then the US markets will follow China's lead downward, which will benefit me due to my short positions in the US markets. However, China could go strong for another 12-24 months, so I would be wasting my money in FXP. In the next month, I will either climb the leader board to take my shot at dethroning Vad, or I will fade into insignificance. My portfolio will boom or bust just the way it is regardless of a position in FXP. Putting a small percentage into FXP won't make a difference when all is said and done.

The second reason I won't short with FXP is borrowed from one of our current top 5 traders, Keith Barton. Back on November 12th in his blog entry, "The term I am looking for is humble", KB lists 5 commandments that dictate his behavior. The first commandment is "Invest in only what you know". I know very little about China, and I will adhere to the first commandment. Yes, in a short period of time I was able to get a general overview of the FTSE/Xinhua China 25. Yes, I can spend several hours getting up to speed on the intricacies of the Chinese markets. Yes, I can plug in methodology to take a short position, but not enough methodology to make money in a month. Vad made money on FXP by timing his entry and exit well. My ego isn't big enough to think that I have that ability. There is a lot of money to be made and lost in bubble markets, and I am not convinced China's is ready to burst just yet. More reading and research is required on my part before I would take the plunge.

A solid case can be made to short China with FXP, and I would like to hear from Vad to get his take on it. My initial take on China investors is that they are not rattled easily. The FTSE/Xinhua China 25 index has been on fire since mid-August, topping out around the beginning of November. Though it has retreated off of its high, it looks like the bull in China has slowed, not stopped. One of the reasons I would consider shorting would be Warren Buffett selling his stake in PetroChina. PetroChina makes up about 8.5% of the FTSE/Xinhua China 25 index, and Buffett thought it was time to get out. Though he isn't a market timer, Buffett and his team saw the opportunity to cash out, which means he doesn't see the potential in PetroChina that he saw when he bought his stake. The Buffett move speaks volumes. Fidelity also sold 91% of its American Depository Receipts in early 2007, according to the Financial Times. An Achilles heel to the index could be the banking industry in China. Almost 27% of the index is in the banking sector, so if there is any type of banking crisis, it could hammer the index hard, although I know next to nothing about any of the 6 big banks in the index. Again, this is another path to follow in research.

One of the most bought stocks a couple weeks ago was in fact FXP. I would like to know your reasons as to why you made the decision. Though I would not buy FXP for this game, I do see a solid argument for purchasing FXP for the next 12-24 months. Here's to hearing your comments.

--Jonathan

Comments: View Comments |  Wednesday November 28, 2007

In a recent blog entry, Keith Barton asked to see an article regarding how to short. His recent blog, "Double? Ultra? That means the brick wall is twice as hard", explains his recent dealings with short ETFs. Though I am far from an expert, I will give the down and dirty of shorting and several reasons you should do it. I will begin by discussing the mechanics of shorting, then discuss how it pertains to the SLO, and wrap it up by discussing the pros and cons of shorting. As many of you know, my portfolio is made up entirely of ultra short ETFs.

First of all, we have to know what shorting really is. Shorting is when a stock trader "borrows" a brokers stock for a particular company and sells it on the open market. After a period of time, the trader returns the borrowed stock back to the broker by buying it back on the open market. If the stock has fallen in price, the trader returns the stock to the broker and pockets the change. The buying back of a shorted stock is called "covering". If the stock has risen in price when the trader covers, then the trader pays the difference and loses money. The goal for "short sellers" is to see the stock fall in price as much as possible before buying it back to returning the shares to the broker. The bigger the fall in stock price, the bigger the payday for the short seller.

In the SLO, you cannot short an individual stock. It took me a while to figure this out. When the game started, I was extremely busy and I didn't have a lot of time to learn the Marketocracy site as it pertained to the SLO. I wanted to short individual stocks, and since I couldn't, I decided to short the market by buying long stakes in Exchange Traded Funds that specialized in shorting. This has actually been better for me since it gave instant diversity and allowed me to do what I wanted in the first place--short the market. I am not aware of the many choices of short ETFs that exist and are able to be traded on Marketocracy, but I am very familiar with Pro Shares short and ultra short ETFs, and my portfolio is stacked with them. To get a full listing of the Pro Shares ETF offerings, go to proshares.com and click on the "short and ultra short" icon, as our SLO brother Keith Barton did. I have been told about other companies offering short ETFs for the Chinese markets, but I have done no research on them at this point in time. My suggestion would be to spend 20 minutes of efficient research to see what is out there and then see if it can be traded on Marketocracy or your personal portfolio. With Proshares, you can also get lower risk short ETFs if the Ultra Shorts are a little too wild for your taste. Instead of getting DXD, which seeks to inversely double the Dow, you can get DOG, which seeks to be a perfect inverse match to the Dow.

Now for the Pros and Cons of shorting. The biggest Pro that I see with shorting is that few people do it. To defeat the competition, you must have an edge. Shorting can be the edge because few do it. Shorting is also much easier than it used to be due to the abolishment of the "uptick rule", a subject I covered in an earlier blog entry. Everyone knows how to buy long because that is what we have been taught since the beginning. Shorting has existed for many decades now, but has never been that popular. Some believe that it is ethically wrong to bet (and hope) that a company will go down and suffer. If you want to beat the other guy, you must do what the other guy is not doing, and shorting falls in that category. Look back at the history of any stock or index . . . there are periods of high times and periods of low times. No one is immune to the cycles, even the great Warren Buffett. Don't believe me? Check out what happened to Berkshire Hathaway. Those investors that bought BRKA at $78,000 at the beginning of 1999 probably cursed the genius less than a year later when it was sitting a little above $42,000. Most people believe that when the times get tough, you just need to buckle down your research tools and find that one gem that will rise as the markets fall. Hogwash. Sell the market or stock short and profit as it goes down. If you buy long, you beat the market when you lose 15% on an investment while the S&P is losing 20% during the same time period, but who wants to lose money? I'd rather stuff my money in a bank and let inflation take its toll than to have large percentages blown away in a bear market. By shorting the market, especially in a bear market, you can eek out gains while everyone else is losing. However, even if you don't eek out gains, the shorts can provide a hedge that will reduce the damage to your portfolio while you wait for the market to turn the corner. Want to know another great thing about the short ETFs? They pay dividends, too!

Another pro with shorting is that you can use the same research in shorting a stock as you do in buying a stock long. What parameters do you use to determine whether or not to buy a stock long? P/E? Technical analysis? Historical cycles? Lunar Cycles? You use research to determine what makes a stock an attractive buy, and you can use the same research to determine what makes a stock an attractive short sell. What makes a company a bad buy? What makes a company's stock take a significant dive over a 6-12 month period? Figure it out, and you can be successful at selling the stock short. I have never understood traders who can put time and research into picking successful long buys while saying at the same time shorting is "too risky". Everyone has been trash talking Fannie Mae recently, and if you believe what you are saying, put your money where your mouth is. Would you short Fannie Mae in your real life portfolio? How far will Fannie Fall? At the end of September, I dumped on the big banks in my blog "An October Reckoning", and since then Citi has went from $48 per share to about $32 per share. Go compute that percentage. You can stack the odds in your favor by shorting in a bear market. China may be in bubble territory right now, so if you could short the China market and the bubble bursts, you celebrate while others cry. It is the ultimate contrarian play. . . sell the bubble market short when everyone is buying. It's dangerous ground in the bubble, but the payoff can be big if you can tolerate the risk. If you can figure out how to spot a company that is going to run itself into the ground, then you will be an incredibly successful short seller.

Now for some of the cons.

Let's use Apple stock as an example of how shorting can't pan out as well as longing a stock. In mid 2006, AAPL was at $50 per share. Now it is over $160, a three-fold gain. If you short a stock at $50 per share and it drops to zero, you make $50, or 100%. If it goes to $160, you have lost over 300%. There is no profit ceiling when you buy long, but there is a profit ceiling with shorts. At the same time, there is a bottom when it comes to losses when you buy long. When you sell short, there is no bottom and the possibility of unlimited losses exists.

Another con is that the stock market, when taken in the long term, always tends to go up. According to the Leuthold Group, a Minneapolis money manager that researches market history, the market goes up 66% of the time and down 34% of the time. Take any twenty year period (as long as you aren't starting on October 29th, 1929) and you will have an overall gain. You will not make money shorting in the long term. Shorting is effective only when you hit it toward the beginning of the bear market or if you are talented enough to spot the bad stocks during a market bull. Berkshire Hathaway plummeted over 40% after 1999, but it turned upward and erased the losses in about 4 years. It is more about timing with shorts, and most people get the timing all wrong. With shorts, you must be a correct market timer two times, once when picking the time to short and another when to cover the short. Since the market is a going up 66% of the time, the odds are against you in hitting it close to perfect both times. When shorting a stock or an index, you must have a pre-determined exit point and stick to it.

There are dangers of losing big in short selling, and I recommend practicing with Marketocracy for a while before trying it in the real world. However, by careful research and practice along with some humility, shorts can be an addition to a portfolio that can pay off.

There are several terms associated with shorting that I will not talk about here, only because I can link you to people that can articulate it so much better. Below you will find two examples, one from Marketocracy and one from fool.com. Marketocracy explains the terminology, and the fool article has answers to frequently asked questions.

http://www.marketocracy.com/cgi-bin/WebObjects/Portfolio.woa/ps/ArticleViewPage/source=MdEcEdBlEbHgJmKiMaKiAbDm

http://www.fool.com/FoolFAQ/FoolFAQ0033.htm

I tip my hat to the SLO leaders; I have watched you from the bottom for a long time now. It's coming down to the home stretch, now let's see if I can catch up.

--Jonathan

Comments: View Comments |  Monday November 19, 2007

In a few blogs and emails, I have been ridiculed, scoffed, and scorned. The nice SLO players just ignore me. I really can't blame you for hitting me for my insanity. You may be surprised to know that I agree with most of your criticisms. The most recent comes from James Anthony in his "A Welcome Market Gift" blog entry, a well thought out and well written blog in my opinion. Vad has made some comments regarding short ETFs, all of which are sound. However, there are reasons why I do what I do. Let me give you some insights to my strategy and game play.

First of all, the statistics show that about 75% of fund managers can't beat the S&P after transaction costs. These are the esteemed, educated, market mavens that we could only aspire to be. Some of those in the top 25% barely beat the market. Some are above average, and a select few are well above average. This gets hidden with Mutual Fund survivorship bias, an ugly truth too big to comment on here. I will humbly admit that I am not one of those elite that can beat the market year after year. With that in mind, I know that when the SLO is all wrapped up, we will probably fall within this statistic, give or take a few percentage points. Because of the 75-25 statistic, I wanted to diversify by having ETFs that tracked the broader markets. Theoretically, if I bought an index fund, I would be able to defeat 75% of the opponents. I sincerely hope there is a full after action report on our performances, complete with individual stats. A SLO player (i don't remember the name, all apologies) has given updates now and then on the performance of the S & P if it were a player. Thanks for that watchful eye on the S&P, and it will be interesting to see how the S&P stacks up against players at the end to confirm or deny the 75-25 stat.

Second of all, statistics show that people who trade frequently have lower returns than those who buy and hold. Again, some frequent traders are part of an elite group that beat the market handily over and over again, but we can't all be Peter Lynch. Most of us have a trading history that doesn't match our egos. I fall into this group, also. That is why, as a rule, I have few trades compared to others in the SLO. So far, I have a total of 37 trades for the entire duration of the game. Only 11 of those trades happened after my initial buy in, and of all trades, 4 are sells (one because of a mistake, another for rule compliance, and the other two because they closely resembled two others I had) . I really don't know for sure how my trading activity stacks up against the average SLO trader, but I view portfolios of the top 100 all the time. Some players have near total turnover in their portfolios, so I believe my trading activity is on the bottom end. Since I am not sure if the data will be compiled at the end of the game, shoot me a quick comment of your total number of trades, even if you are not in the top 100. It will be interesting to see if the frequent traders in the SLO end up being concentrated or evenly dispersed throughout.

Thirdly, in order to beat the broad markets using broad market indexes, I would either have to use ultra long ETFs or Ultra Short ETFs. This is where I go off the reservation and get declared clinically insane by the SLO clan. Nobody stacks a portfolio with only Ultra Short ETFs or only Ultra Long ETFs. Most follow the Vad approach and get long or short ETFs to "decrease the volatility of the overall portfolio". I chose to stack my portfolio with Ultra Short ETFs.

Why?

My choosing Ultra Shorts was a result of a few things. The biggest reason I chose Ultras was for their high risk. They aim to double or inversely double the index or sector they follow. With Ultra Shorts, I only have to make the right decision on which way the market will go, either up or down. If I am on the right side of the market, then my portfolio will theoretically double the return, although it doesn't quite do that in the real market. It is better than picking individual stocks because I will pay for only 1 mistake, that is, being wrong about the direction of the market. A mistake on an individual stock may cost me and it would never recover. Ultra ETFs can go from a 20% loss to a 20% gain and back again quickly.

Do I go Ultra Long or Ultra Short?

That was an easy one for me. We are in one of the longest running bull markets ever. Markets have cycled up and down since the advent of markets. Even those good old days of Nasdaq 5000 will come back if enough time elapses. Being in a long lasting bull market coupled with the problems in real estate and banking make me bearish. The lowering of interest rates may make inflation pop again, although, maybe not soon enough for me. The "R" word keeps getting thrown around, and the high price of oil and gasoline exerts pressure. I also read a lot of MSN's whipping boy, Bill Fleckenstein, who would devour Goldilocks if given the chance. The bull cannot last forever, as well as a bear cannot last forever, but they do come and go. Choosing the Ultra Shorts not only guarantee that I will beat the market when it goes down, it will also mean that I will beat many of the SLO players that have went long on individual stocks that get pulled down when the bear rears his ugly head. In addition to this, no other SLO player has the stones (or the stupidity) to load up on the short side like me, so if the market tanks, I will be toward the top.

These are the three points of my strategy: Buy Index and Sector tracking ETFs, have few trades, and go Ultra toward the short side. Built into the strategy is an assumption that I can take the pain of big gains and big losses. It's an amazing thing, really. None of the money is real but the psychological effect of seeing a 10, 15, or 20 percent hit will rattle you, even when you know it's coming. The temptation to bail is always there after a sustained loss. Now it doesn't even faze me. The 300 plus Dow gain on Tuesday didn't even make me flinch. Again, most players believe this is insane, and if the markets stay within 5% up or down of where they are now, then memories of Jaudio will go into the SLO ash heap never to be heard of again. However, if the markets get pounded down, one percentage point at a time, my portfolio will rise from the ashes and the lunatic will be running the SLO asylum while players spit in my direction at the luck.

"The key is not to have a secret trading strategy, but rather, have a public strategy so cockamamie no one will follow it".

Comments: View Comments |  Wednesday November 14, 2007

The short side traders in the SLO get no respect. We lack Net Asset Value, causing our "Fund Envy" to make us prone to irrational behavior. When our portfolios get ravaged by the never ending bull market, we double down in our quest to make up for our shortcomings. We want our time in the sun, and we want status. For once, the Napoleon complex may be paying off.

Through September and October, my portfolio could be compared to a farm that had been hit with drought, striking farm workers, a plague of locusts, and a field fire. At one point in time, there were several of my short ETFs that were close to a 20% loss, and some well beyond 20%. Digest that one for a moment . . . numerous -20% numbers staring back at you on the screen is nothing short of gut wrenching. Some would rather see the rivers turn to blood that stomach a 20% loss. I can only imagine the much greater feeling of disgust real traders had back in October of '29 and '87. I pale in comparison.

Nevertheless, I have held true and not bailed on the ETFs I bought for sound reasons. As with all SLO traders, had I hit at the right time, I would be in great shape. A couple weeks ago I made a case for SKF and SRS, the Ultra Short ETFs for financials and real estate. Both have been stellar since their October lows. Just one month ago SKF was sitting around $74 per share and SRS around $80 per share. Now they are sitting at $99 and $105, close to a 33% gain for SKF and 31% gain for SRS. The great thing is that these still have room to run. The market is now in the midst of ridding itself of denial about financials and real estate. It isn't that the prices are reflecting the current situation. Rather, they are reflecting what we know about the situation in the past few months. It took a while to get into the mess, and it will take a while to get out. These markets will eventually recover, but don't expect a financials and real estate rally during an economic slowdown, and yes, the economy is slowing down. SKF and SRS are risky Ultra Short ETFs, that is, when the sector goes up, they get doubly hurt since they seek to inversely double the return of their respective sector. However, if SKF and SRS get popped 2-3% (as they are accustomed to from time to time), look at it as a buying point, take your position, and ride it to the end of the game. Even if other sectors stage a small rally, the financials and real estate will be down for several months.

The best buy on the short side I am seeing right now is QID, the Ultra Short Nasdaq ETF. This is by far my worst performing holding. Even after rising 4.5% in one session, I am still down almost 20% due to my entry in August. How do I come back from a blow like that? Well, I am going to drop another $40,000 on QID.

Why?

I am insane, that's why. No really, it's a matter of acknowledging I was wrong about my first entry point and doubling down at the correct entry point. QID gained 4.5% yesterday, and I expect the short sellers to cover in order to lock in some gains, so there should be some retreat. I would like to see a 2% retreat to get back in, but if not, I will buy regardless of what happens on Monday morning.

Tech has been a bright spot in the market volatility in the past 2 months. When the DOW and S&P had rough days, the Nasdaq was not so rough. In fact, QID is one of the few short ETFs that is only a few days removed from its all time low. Back in August QID reached a high of $50 when the Nasdaq followed the DOW and S&P downward. This time the Nasdaq has remained resilient. That's contrarian speak for "short buying position". QID reached an August high of around $50, so at $36 a share now, it would be a steal. When the Nasdaq follows the other markets downward, look for QID to crack that $50 mark again and lock in a 38% gain.

Don't fear a market downturn-- bank on it. Don't sock your money away under the mattress--buy Index tracking ETFs. It may not be time to swing for the fences yet, but don't let the hanging curve get by without trying for a base hit. Opportunity seldom knocks; fear is leaning on the doorbell.

Comments: View Comments |  Thursday November 8, 2007