Shorting Portfolio

16th Feb '16 by Investor & Trader

16 comments 16841 reads

Hi, Would you consider presenting a naps portfolio for shorting shares too, or are you not allowed to discuss promote shorting on the site?

Just wondering as im thinking of trialing a short selling portfolio (with stops...) based on low ranking i.e 0-5 as there is a fairly consistent down trend based on your histogram.

Any advice would be appreciated.

Regards
Gary

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Investor, Trader and Financial Educator As a long term investor/trader I have consumed hundreds of financial books and endured countless hours of self education. Hopefully my contribution through my channel will reduce the learning curve duration of many aspiring traders by providing the key information in a concise and enjoyable manner. https://www.youtube.com/channe... more »

16 comments

BlueFrew

17th Feb '16

The big problem with a lot of the lower ranked shares is market capitalisation. It's a lot easier for a bulletin board ramp to double or treble the share price of a company with a 10 million market cap than one with say a 100 million market cap. Even if you wanted to short the smaller companies in many cases it's not possible to get any borrow.

I'd say a good rule of thumb would be to only look at shorting candidates above 100 million market cap. Even then, you'd want to do quite a bit of research before pulling the trigger. Of course there are always exceptions. Were it possible to get borrow on some of the remaining Chinese AIM stocks I'd short them regardless of market cap. There are still some decent candidates with low stock rank and above 100 million. I'm short Avanti Communications, for example, at the moment.

Investor & Trader

17th Feb '16

Thanks BlueFrew,

I noticed on IG index a number of the shares as you suggest do not allow borrowing, and many of them do not allow a guaranteed stop loss either.

Nick Ray

17th Feb '16

I can think of some problems with a "NAPS" style short portfolio.

Going short has only a +100% upside but an unlimited downside whereas for a long portfolio it is the other way round. This means that there is a bias towards unlimited loss and therefore stops are essential. However you are also vulnerable to gapping, and corporate actions (such as dividends and rights issues) as well as the fact that the trade can be closed at any time if the borrowed stock has to be returned.

As a consequence short positions usually work better as short term trading positions than as long term bets on trend so the mechanisms for review of the portfolio would need to be different. Short positions cannot be ignored for months on end.

The fundamental reason that a short has limited upside is that the stake you have in the bet reduces as the bet moves in your favour. So when the price has fallen by 50% (+50% in your favour) your stake is now only 50% of what it was. So to keep the portfolio balanced you would ideally increase the stake in proportion as the stock's price fell and, equally, reduce it if the price rose. This is again really only an issue if you are trying to run shorts for a long period to exploit a bigger overall move.

An obvious reason to consider shorts in the present climate is to act as a hedge against a bear market. In theory a portfolio with a balance of long and short positions might be 'market neutral' and so you would have an absolute return regardless of market sentiment. In practice the problems I've mentioned above stop this from working symmetrically. So it tends to reduce returns in a bull market but does not have a reliable effect in a bear market because the position rapidly becomes unbalanced in the wrong direction.

So I don't say that you can't make it work, but the mechanics are not as user-friendly as long-only strategies. Someone will probably correct me, but it seems to me that traders who have famously made huge profits "shorting the market" (such as during the "credit crunch") did it with options, or derivatives which behaved like options, thereby giving them a limited downside in case the bet went wrong.

tomomo

17th Feb '16

Paul Scott mentioned, I think on Twitter, that he'd made a 100% return on his long/short trading with IG since ??the beginning of the year??. Perhaps I've got the details of that slightly wrong. But an amazingly good performance. He also said he was closing positions down now, though. Evidently very much a short-term trading approach, not a longer-term hedging intention.

I had really good returns immediately when I first started shorting using a very primitive StockRank-based approach. I got almost immediate precipitous 30%+ down moves on a couple of shares. That got me interested, but I subsequently found shorting much harder and overall lost money. Shorting Tesla last year would be an example of the kind of problems I had: rightish idea at the wrong time without the skill/conviction to be willing to hold the position (or the patience/skill to wait for the right time to open it in the first place).

I'm reasonably sure you can make a better-than-market return with very little effort or knowledge following a StockRank-based NAPs approach. I'm highly doubtful you can could have a similar level of success for a similar investment of time and knowledge on the short side: I think the demands for attention, nimbleness, market nous and discipline are much higher for shorting.

pka

17th Feb '16

If you are thinking of using a long-short hedging strategy, you might consider investing in the City Financial Absolute Equity OEIC, which has done very well relative to the FTSE All Share Index over the past five years:

http://www.trustnet.com/Factsheets/Factsheet.aspx?fundCode=BEFF0&univ=U

There is no guarantee, of course, that it will continue to do so well in the future. The methods used by the manager to select the stocks to go long and short on have not been revealed.

Anyone thinking of investing in this fund should bear in mind that it has a performance fee that seems very generous to the manager and therefore not so great for investors, although the performance fee does have a high water mark.

Investor & Trader

17th Feb '16

Thanks for that Nick, food for thought there...
Interesting point you make regarding the reducing "bet" as it moves in the short positions favour, something I never really considered.
My general Idea had been to consider shorts on stock with a cap above 500m and a stock rank between 0-5 with some further analysis. I would include a stop loss but it would have to be without an allowed guaranteed stop loss.

I may run a demo portfolio and see how it progresses.

Tortoise investor

19th Feb '16

Shorting has been something I've been meaning to look cautiously into. Does anyone know if any of the platforms (like IG) offer a fantasy style shorting portfolio that allows you to practise without real money?

Investor & Trader

19th Feb '16

Not sure, but a replica could be created on stockopedia which is what I have done.

Would the more experienced shorters here be more cautious towards pharmaceutical and biomed companies etc what are your feelings towards sectors in this regard? I see a number of low ranked stock fall into such categories as they are not profit making.

tomomo

19th Feb '16

You can set up a demo account with CMC and, indeed, run it parallel to an active trading account.

I use CMC much less frequently than IG. In my experience it is very good, but I have not used it for betting on share price movements -- only for fx and occasionally commodities.

cig

19th Feb '16

I doubt there's a platform anywhere that simulates borrowing costs, forced position closures, shorting suspensions or even gaps over stops accurately (it's hard to do, and not in their interest...). You're probably better off playing with spare change amounts of real money.

AnonymousUser34554

19th Feb '16

If you cannot short a stock on IG Markets / CMC Markets for example Game Digital (LON:GMD) is there anywhere else to go, are any brokers better suited for this?

Seems weird that an almost £200 million cap company cannot be shorted unless I'm missing something.

tomomo

20th Feb '16

cig

I'm surprised if that's true. The CMC demo account operates with a fictional allocation of money (£10,000 initially, I think). Otherwise it's apparently identical to the real thing. After logging in you can switch between the two accounts by pushing a button in the top corner. If there is really a difference between the two accounts, apart from the obvious, it's not evident.

I don't really follow the reasoning either. Why can't they just run demo accounts exactly like real accounts? As I understand it, the whole thing's basically a bucket shop. They presumably just ignore demo account positioning when hedging their exposure.

It may well be in their interest to do this: I used a demo CMC account before getting a live account, and I'd guess other people do this too.

Using real money may be a better way for some people to get used to spread-betting than using fictional money (though fictional money may be better for exploring a new kind of trading). A few years ago some spread-betting platforms would allow new clients to use miniscule bet sizes. I don't know if they still offer this. I personally found it a useful way to get used to staking money.

BlueFrew

20th Feb '16

I can't remember who, but somebody mentioned, on a post here, that Spreadex can sometimes open shorts on stocks that aren't possible with IG. That's been the case in my experience. I managed to short Petroceltic with Spreadex after I had to close with IG, because IG lost borrow.

It's sometimes worth phoning IG as well. They'll sometimes be able to open a position for you on "unborrowable" stocks.

AnonymousUser34554

20th Feb '16

Thank BlueFrew very helpful I'll be giving IG a call.

cig

21st Feb '16

The UI can be identical, it's the execution engine that differs.

For example, the execution price of stop losses/margin liquidations (both long and short) cannot be simulated exactly without placing live orders for positions that involve a hedge. In quiet/liquid markets the simulation will be pretty close, but shorts might be on stocks prone to events where the difference matters. Even for pure house positions, some of the more dodgy operators may bias both sides (the simulation to be generous, the real trading to give an advantage to the house).

When you short in quantity or your order makes the house position hit a limit, a live hedging order can go up to the real markets while-you-wait. Sometimes the upstream order will fail, making your order fail. You cannot simulate that without actually executing the upstream order. Same for forced closes of open positions when the hedge is recalled and can't be replaced.

When you are holding a short position more than intra-day, and you're not short against longs with the same broker, they pay upstream borrow costs that they will likely pass to you if they're material. The daily value varies with demand and supply. It's usually not much but can be expensive for popular shorts, so as to seriously truncate your upside. Tricky to simulate, and why do it (it may make the client aware of borrow costs!).

There are probably some other issues I haven't thought of.

tomomo

21st Feb '16

cig

Thanks for educating me! Clearly you know much more about this than I do.

So far as I can tell what you're saying makes sense and seems plausible. Though it seems that in practice there won't be that much difference if you always use guaranteed stops, keep your account well funded, and have small position sizes. Particularly if the stocks you short with a demo account are also shorted by clients with live accounts (which would presumably mean a reputable spread-betting provider would apply real borrow costs to the demo account positions).

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