The Path to Shorting is Long

• Posted by Derek
• on February 16th, 2011

This bull run of recent months should have taught lessons to anyone lacking respect for the power of markets.  Macro thinking is just an intellectual exercise unless backed by a sound plan of entry conditions, position size, and exit conditions.  What we’ve had is a market that alternates from “Buy” to “Stop Buying” and back to “Buy”; we’ve had only some stock-specific “Sell” triggers, and almost nothing resembling a “Short”.

I’m happy to have stayed in the “Buy” and “Stop Buying” zones, with a few drifts over into the “Sell” lane before being jerked backed into sense.  But “Short”?  That’s like crossing the highway and doing a U-turn; markets allow you time to use the exit ramp first.  I still look, because it’s part of my trading DNA…$FOSL caught my eye Tuesday AM for standout weakness.  It even obliged by dropping 3 full points from its opening range.  But look where it closed…right back into the opening range.  So unless I was able to both short AND cover it correctly, I’m taking a scratch on what was a decent intraday idea.

That’s the problem with counter-trend trades; both entry and exit require precise execution to avoid loss.  With the trend, however, one has a tailwind to give some cushion on both the entry and the exit.  Brian Shannon said in his book, “in an uptrend, the sum of the rallies will always be greater than the sum of the declines.”  Simple math.

Debate the merits of the economy, valuation, QE2, or whatever troubles you about this market.  But keep the debate off your position sheets.  For the market to start rewarding short ideas, it needs to stop rewarding long ideas first.  That moment hasn’t arrived, so the burden of regret falls on the bears and sold out bulls.  To me, regret is the most powerful of drivers, causing us to adjust our expectations incrementally while our plan creeps without our knowledge from reason to emotion.

Rather than wait to acknowledge it, why not measure it daily?  Keep track of your last 10 trades(and 5 setups not taken), and see where regret may be buried.  This is the most universal of indicators; no matter one’s timeframe or style, tracking how the market has treated our ideas tells us whether we’re underbullish, overbullish, or totally in tune.  Based on the last 10 trades in my 100k model, I’m underbullish as I have been since the emerging markets divergence altered my thinking in early December.  Still willing to buy, but WAY more likely to pass on entries in my leaders list.

Until investors start feeling a sense of regret for their long trades, the trend will remain up and away.  A risk-aware operator can be forgiven(I hope!) for drifting to underbullish on occasion, but that error should result in “Stop Buying” decisions and be adjusted when the next round of setups arrives.  Moving to a “Short” stance may seem logical given the steady drip of deficits and violence, but it ignores the legion of doubters who are still slowly adjusting to their latest sense of regret.  Regret that they didn’t move to bond funds in 2008, then regret that they didn’t have enough allocated to emerging markets, then regret that their IBD stocks got taken away by stops in the Flash Crash.

I’m a trader, not a writer, but look at me writing this piece…was I bold enough to write it last summer?  Probably not, too much caution that I now regret.  I’ll regret writing a “Don’t Short” post if the market crashes next week, but the trader in me will have adjusted my thinking long before the writer in me is confident enough to do the same.  I haven’t regretted ANY buys in the last few months, only sales…when that changes it will be the most objective indicator of all that we can adjust our direction.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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