Shorting the Market

Investors who feel that a public company is over-valued because of high valuations or a flawed business model can try to capitalize on that belief by “shorting” the stock. The term shorting a stock or short selling a stock is used to describe the act of borrowing a stock and selling it in the hopes of buying it back in the future at a lower price. It is essentially a bet that the stock price will fall. With the proliferation of exchange traded funds (ETFs) it is now very easy to short the entire market with the purchase of a single fund. Moreover, there are now triple leveraged long and short ETFs. These allow investors to bet on the direction of an index and make or lose three times the actual gains or losses of the underlying index. Because these leveraged ETFs use derivatives, they are rarely suitable as long-term investments and should be used only as short-term trading instruments. Technical analysts are typically unconcerned with the fundamentals of an investment like free cash flows and price-toearnings ratios. Short term traders typically rely on information like trading patterns, money flows, and investor sentiment (as a contrary indicator) to make short-term trading decisions. Traditional money managers rely almost exclusively on fundamental analysis and are relatively unconcerned with short-term price movements. Most fund managers are mandated by their clients to stay fully invested in their asset class. Therefore, they are not expected nor even permitted to short the market. Over long periods of time, that has proven to be an effective approach. However, during recessions and significant market corrections, long-term investors have no other option but to ride out the volatility and wait for the market to come back. Tactical traders who are willing to short the market can potentially make large profits during big corrections. Limited exposure to these types of managers could be an effective hedge against the next big downturn.