Complete Stock Idjit

Double? Ultra? That means the brick wall is twice as hard

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Education week is what I called it.

I started off researching short funds to see what additional tools were available, the market assisted me with an environment that seemed to trend downward most days.

Part of the research was simply to witness the behavior of short and "ultra" short securities to see what kind of protection they offered, the balance was to learn what kind of vehicles were available. The Market is just like Las Vegas, as they make "book" on anything - digging out those esoteric funds was the first step.

That turned out to be the easiest part of the exercise as the ProShares website offered enough of them for me to be studying for many months.

I saw a couple of desirable outcomes:

a) Playing Defense: If I am long financials, and financials start to plummet, can a hedge protect me from any loss - and if it can, how much would I have to purchase to cover the long position?

b) Playing Offense: In a period of mixed market activity, wherein I think the long term trend is down, is it possible to treat shorts as a profit tool?

I knew I wouldn't be able to get a definitive answer to either question in a week's worth of transactions, but I did hope to gain insight into their behavior to begin my education.
Education is always painful, it's not often I put my nose in a collision course with a brick wall, but after the wound is bandaged, I usually have learned something valuable.

I started with the Big Stuff, shorting the major indices. SDS (S&P), QID (Nasdaq), and DXD (Dow30), and the results were poor. "Big Stuff" never behaves like an individual stock, no "rocketship" upward, nor calamitous downward spiral. If I guessed correctly (on the Index I shorted) a 1000 share purchase yielded around $1000, sometimes more, oftentimes much less.

Lesson Learned: Shorting the "Big Stuff" will not be an adequate hedge against your long position, it may lessen the impact of the bullet, but a fast paced downward move will still remove your spleen.

Lessening the damage is OK, as it's part of the known Market game, you cannot be right all of the time, so "not being hurt as bad" is still a form of moral victory. You just can't afford to pay for the kid's orthodonture and college, at some point he'll have to get a job...

A couple of days opened poorly and went further south, with a position of 2000 shares each of QID, SDS, and DXD, all I salvaged was $5000. These were not "dramatic" down days, perhaps the Market was down about 100 points. Factoring in the costs of the securities, ~$300,000, it's a rather poor rate of return.

With a long position of $1,000,000 the loss was $27,000, the shorts made that $21,000. From this single day, I would have needed $1.50 short for every $1.00 long to cover the portfolio completely.

By Friday I was ready to short the "Smaller Stuff" - individual industries. I assumed they'd behave more like a stock than the large indices, but still not have radical movement like an individual company. It's still all guesswork, meaning there's nothing inherently easier in picking an industry versus a stock, many web sites (like Google Finance) show the behavior of the industries, but you still have to guess whether it will continue in one direction or another.

I didn't have an opportunity to test the smaller indices with the same vigor as earlier in the week. I ran out of trading days was largely the issue - so I'll continue the "brick wall nose flatten" educational process next week. A word of warning is also in order; as these smaller short funds trade much smaller volume than other stocks. The Marketocracy simulation only uses a portion of the market in its trading, it takes forever to accumulate a normal position in the esoteric shorts.

I tested a hedge of my "Basic Materials and Ag" SLO fund with the SMN (Basic Materials Ultra) Short, and it took 25 minutes to fill an order of 1000 shares. In the market we're currently in - 25 minutes is a lifetime, as it can spiral either direction 100 points or more.

I have to guess, but a smaller order should be filled quicker, so you may want to buy these 100 shares at a time. I will have the same trouble selling this beast, so a word of caution for those that may attempt something similar.

Extend that word of caution to any of my advice actually, never invest based on the opinion of a guy rubbing his nose...