What to do if it goes south?

30th Jul '17 by vik2001

3 comments 3733 reads

Ive always been long in my portfolio when I started investing 2 years ago.M
y portfolio is diverse consisting of UK, European, US, and EM stocks. the only thing is I never considered how I should protect my portfolio when things go bad. I once shorted a stock thinking it would provide me with some short term protection as well as some gains, and lets just say that ended badly - but lesson learnt I realised how shorting is a risky business.

What should I be looking at for, when markets go south? what can I invest in to protect my portfolio/gains??

Appreciate views from the more experienced in this matter. I still believe we in a bull run, but I don't want to panic and sell stuff off if markets change.

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About the Author

Vik2001

Premium Member

3 comments

Mechanical Bull

31st Jul '17

I’ve spent the last four months exploring how I might go about shorting stocks to protect against a sharp correction. From what I learnt from both reading and first-hand experience is that going short is more difficult than going long for a couple of reasons:

1. In general going short is less profitable because markets tend to rise over the long term.
2. For individual stocks, potential losses are unlimited while profits are not (i.e. you can’t multi-bag). When shorting, you absolutely must use stop losses.
3. Compared with investing long in stocks, there is no “simple” way of shorting and the practical means of doing it have different pros and cons (mostly cons!).

Put options expire and the longer the expiration, the less favorable the spread. Similarly, spread betting trading costs increase the longer the position is open. CFD shorts are maybe the closest thing to normal investing, but in practice, many stocks cannot be shorted due to borrowing restrictions on the underlying market.

I’ve gone with CFDs as it seems to be the least worst option. Basically, my idea is to short low Stockranks to compliment my long portfolio of high Stockranks. I have done some back testing which suggests that on paper this kind of strategy should work pretty well. For now I am doing this just as a demo on IG to gain some experience before deciding whether to do it for real.

I always use a 10% stop loss, although there are no doubt more sophisticated ways of setting stops. With CFDs you trading on margin and the tightness of stops have an impact on the margin. In my case, I am able to cover 100% of my long positions with an outlay of just 20%. However, there are also associated borrowing costs, which I have worked out amount to about 2.5% pa. Also, it is important to be aware that dividend payments will get taken OUT of your account. This is logical if you think about it, although it was an unpleasant surprise to me!
I am four months into my experiment and although I was up quite nicely at one point, I am currently back at break-even. My stop loss has been bit a disconcerting number of times and nothing has really tanked as yet. My exit strategy is to use a trailing 10% stop, but again, I am sure that there are more effective strategies out there.

My conclusion is that unless you are an extremely sophisticated investor, shorting should not really be considered a means of making money. Rather it should be used as a form of insurance against big losses. Over the long-term you may not make any more money than just going long, but it should certainly help ensure against big losses and deliver smoother returns over time.

JohnEustace

31st Jul '17

Really I think the best advice is if you're not happy to hold it for five years then don't hold it for five minutes.

That being said, I have never shorted an individual share but in the past I've had some success with short ETF's. SUK2 is one that Robbie Burns uses. In theory put a third of your money in this double short ETF and you're hedged. Of course it's not that simple in practice and you need to look at the way the maths works. But in a sustained downturn it's a useful tool to have.

slibbertygibbet

31st Jul '17

Be careful on short ETFs - the way futures/options contract pricing works, they are recalculated every day and you find the capital 'evaporates' unless the downturn is sustained. SUK2 is really designed for intraday trading. A spreadbet would be a better option over a period of days/weeks.

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What to do if it goes south?

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Vik2001

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