Friday, January 25, 2008

The Short Side of the Market

The stock market has been up 300 and down 300. It seems a little peculiar unless you understand one principle. You can make just as much money in an up market as you can in a down market.

When I first started buying stocks (a long time ago), I was able to turn $5,000 into $3,000 with no problem. Then as the bull market progressed, I got better at what I was doing (I’m lying). I was always inquisitive, I asked my broker once, why he never recommended any stocks to short, only ones that were a “good buy.” His answer at the time didn’t really sink in until now. He said, “Most investors want to be positive about the market, being negative is bad for stocks and business in general.”

When markets start to drop like they have lately, many people start selling the market short. They borrow shares from the broker that are held in street name. So if you wanted to short 100 shares of XYZ that are trading at $100, you would have to have 50% of its current value in your brokerage account. An investor that is "Dead certain" on the future of the market is liable to short to the max. $10,000 in his account allows him to short $20,000 of stock. If the stock pops up $20 then he has a margin call of $4,000 (200 shares x $20). So if traders are seriously shorting a stock and it turns around and goes up they have to cover. The stock could shoot through the roof. A real neat thing is, if the broker feels that the stock has moved too far, they can buy it back without calling you, which can be quite irritating. The stock could go up $40 on the open and they buy the stock and close you out. Later in the day it drops $70, you owe the amount where they settled your account with a buy confirmation, not at the close where it is down $70.

At first glance, it looks as if the market is back to normal, going up. This is your typical Bear Trap. The market goes up when it should be going down (by all logic) and the shorts literally take it "In the shorts." They have to buy to limit their losses or add to their margin account, with their broker.

This is why markets don’t go straight up or straight down. There is money to be made on people that bet the farm on one side or the other.

The rate cut by Bernanke, gives one a feel for the presence of the current market. His actions indicate that something is seriously wrong. The stock market moves pretty much independent of his actions, but psychologically, the market is a reflection of perceived future events. Imagine being in the lifeboat line on the Titanic and the captain of the ship is ahead of you, you know you're in the right line.

The market has burned the hell out of the shorts, these players always bought back into the market, to realize their gain. They gave the market some stability. Now there are fewer shorts to buy on the dips. That could speed up the next drop.

The thing that scares me, is that Congress is giving us all some money back to stimulate the Economy. Bernanke is going to lower the interest rate another half point. It’s kind of like a hooker giving away free sex, there has to be a catch. Why should anyone take these measures at face value? From a government perspective it makes absolutely no cents!

Copyright 2008 All rights reserved

3 comments:

SACKERSON said...

I suspect that in a bull market, evrybody floats up effortlessly, but in a bear market, the pros sell to the amateurs every time the latter think happy days are here again, then buy in again on the dips. My wife says she saw a cartoon recently of two white bears, one glum and the other dancing ecstatically, captioned "bipolar bears".

Jim in San Marcos said...

Hi Sack

Sounds cute.

I can remember reading somewhere that buying the dips from 1929 to 1933 would have left you with only 10 percent of your original investment.

Retirement could be further off than we think.

SACKERSON said...

Agreed, but the chart I copied on 24 January tempts the day trader to try buying on the dip and selling on the temporary recovery. One for Soc Gen, I think...