Notes on Shorting Stocks

Unlike going long on stocks, shorting stocks (at least by our experience) requires a more technical approach.

When we are long a stock, and it moves against us, the net impact of the name in our portfolio diminishes. For example, a 10% drawdown on a 1% long position leaves the stock at 0.9% (10 basis point loss) of the portfolio, such that another 10% loss only impacts it by an additional nine basis points.

When we go short a stock, our risk is compounded by the fact that the size of the position gets larger when the stock goes against us. For example, if we are short say 1% of X, and it rallies 20%, we lose 20 basis points and our short position is now worth 1.2% of the portfolio. Another 20% rally impacts the portfolio by an incremental 24 basis points, and the position is now worth 1.44% of the portfolio. Unlike going long, we cannot afford to wait it out.

This is why ATEC feels that timing (and technicals) is an even more crucial factor when it comes to going short.

After we have done our fundamental work on a stock, we look for what we term a “Setup”. It essentially refers to the confluence of both Fundamental and Technical conditions, pointing to an imminent change in trend for the stock. It is not too dissimilar to going long, but what we are trying to achieve here, is to more consciously control the risk of going short by timing the stock, for the reason cited above.

Then comes the trigger to go short. Of course, the trigger point would have been established during the “Setup” phase as we prepared for the trade. In this case, we had identified the trigger to be a break below of the 20 Day Moving Average (and with volume) to enter the short (see illustration below).

Source: Bloomberg

This identified trigger point also serves an important function of being a ‘Reassessment or Risk level’. If for whatever reason, the stock recovers above it for more than a day or so, it tells us that we are already wrong on our timing (if not the case), and can help us control the damage by the position.

Shorts tend to work faster than longs since the dominant driver behind them, being fear, is arguably a more potent emotion. Hence, even as the short is working, it is important to establish where you think support might kick in so as to cover it before selling exhaustion kicks in.