Shorting stocks during a crash?

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qwe7791
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Shorting stocks during a crash?

Post by qwe7791 »

Is there such a thing? I was reading over shorting stocks today and I was curious if that's possible. Since so many people are probably selling their shares like crazy, wouldn't the person who short stocks make huge profits during this time or is shorting restricted during these types of situations?
Last edited by qwe7791 on Thu Dec 24, 2015 5:15 am, edited 1 time in total.
EarlyStart
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Re: Shorting stocks during a crash?

Post by EarlyStart »

qwe7791 wrote:Is there such a thing? I was reading over shorting stocks today and I was curious if that's possible. Since so many people are probably selling their shares like crazy, wouldn't the person who short stocks make huge profits during this time is shorting restricted during these types of situations?

Yes, profits from short selling occur every day and in a big way during bear markets. If you're not very, very skilled in quantitative financial concepts, you should stay 100 yards away from this kind of thing. Here's a recent example:
His name is Joe Campbell, and he claims he went to bed Wednesday evening with some $37,000 in his trading account at E-Trade. One notable development on the pharma front later, and Campbell woke up to a debt of $106,445.56. Now, he may end up liquidating his 401(k). And his wife’s.
And I don't think this guy is dumb. He just managed risk poorly. So in summary, yes it is possible to use the leverage inherent in options to make a lot of money when stocks go down, and it's possible to ruin your life trying.


http://www.marketwatch.com/story/help-m ... 2015-11-19


Here's a common way to estimate the fair value of an option, in case anyone's curious:

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red5
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Re: Shorting stocks during a crash?

Post by red5 »

qwe7791 wrote:Is there such a thing? I was reading over shorting stocks today and I was curious if that's possible. Since so many people are probably selling their shares like crazy, wouldn't the person who short stocks make huge profits during this time is shorting restricted during these types of situations?
Don't try it. Stay invested. Stay your course. So many people AREN'T selling their shares like crazy. It is incredibly impossible to predict when crashes are beginning and ending.
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qwe7791
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Re: Shorting stocks during a crash?

Post by qwe7791 »

I know shorting stocks during regular bear markets can be profitable, but highly risky. However, is the risk substantially decreased during crashes such as in 2008-2009? From my perspective, if I short at a high price during a crash, I'm most likely going to see stock prices dwindle over a period of time unless the stocks I'm shorting somehow bounced back up during a crash. Is my thinking flawed?

And I'm definitely not going to try it, but this idea just popped up in my head and I was just super curious. Thanks for the responses so far! :)
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Maynard F. Speer
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Re: Shorting stocks during a crash?

Post by Maynard F. Speer »

$billions were made by hedge funds shorting emerging markets on the Chinese crash not long ago

But as noted above, effective short-selling is as much about risk management as it is market timing - so you don't normally see these shorts showing up as huge profits, because they were perhaps 15% positions .. and may have simply offset losses against other assets

Hedge funds I follow which did best through 2008, for example, tended to use some combination of derivatives, to protect long positions, and picking the right flight-to-safety assets - which were mainly the Swiss Franc and Japanese Yen .. I like to have 10-15% in long/short equity funds now (although it took me a while to warm to them)
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Toons
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Re: Shorting stocks during a crash?

Post by Toons »

Easy.
All you need to know is when the next extended declining market is going to occur.
And for how long. :happy
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Valuethinker
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Re: Shorting stocks during a crash?

Post by Valuethinker »

Generally in a market crash it must be hard to make money shorting.

Because there are so many people trying to do it, you will pay a premium to get stock on loan-- at least I imagine so.

Of course as others have pointed out, if a stock ticks upwards, then you can get margin called (put more cash into the account) on your short, and even forced to "short cover" (ie liquidate the position and possibly crystallize a loss). When Porsche was secretly buying VW, the short squeeze cost the hedge funds *billions*.

This is a very different risk profile from long-only investing where you can only lose what you have invested.
wxz76
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Re: Shorting stocks during a crash?

Post by wxz76 »

Read this article first before you start shorting stocks.

Man begs for money after risky bet implodes
bigred77
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Re: Shorting stocks during a crash?

Post by bigred77 »

Individual Investor's who want to take this kind of position (foolishly in my opinion) would be better off buying Put options than actually short selling a stock.

Perhaps the Boglehead way to do this would be to go short on Index futures? Don't Bogleheads always say to never short individual stocks?
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Maynard F. Speer
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Re: Shorting stocks during a crash?

Post by Maynard F. Speer »

Certainly, the long/short funds I hold seem to prefer options

Image

I've never been tempted to short .. I think good shorters are possibly the most talented people in finance - and they've usually got a whole team of analysts and managers supporting them ... If I was any good at it, I'd go work at a hedge fund myself
"Economics is a method rather than a doctrine, an apparatus of the mind, a technique of thinking, which helps its possessor to draw correct conclusions." - John Maynard Keynes
MnD
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Re: Shorting stocks during a crash?

Post by MnD »

You don't know when the market is going to crash so shorting the whole market is difficult.
The market can stay irrational (keep going up excessively so) for a lot longer than you can stay liquid in a short position.
You have to pay the dividend on anything you short so shorting the market has a significant drag of the dividend expense ratio. Unless you are a very wealthy big-time investor your brokerage will not pay you interest on your short proceeds (not that interest has been a factor since 2006).

So short right when it is crashing? I made a huge purchase in 2009 of ETF's (my last rebalance of the financial crisis) when the Dow was down 600 points mid-morning. I think it ended closing up 350 points that day. Good luck shorting when the market is crashing - and you somehow know it will continue to crash how?

I used to short non-dividend paying individual stocks with some success, although almost always I was short at a loss for a significant period of time until reality caught up with them. It just wasn't worth the stress.

And then you have the problem of finding shares available to short for almost certain losers. I have been trying to short Sears Holdings for over two years, checking maybe 10 times in 2 years and every time my very large national-scale brokerage has no shares available to short. In two years the shares have dropped 50%, I had the knowledge, means and motivation to short it - and still no dice.

Lets check again today on shorting that Sears/Kmart retail juggernaut......... Sorry Charlie

This stock is either ineligible to be shorted or shares must be borrowed externally. Lenders of hard-to-borrow securities charge a fee in the form of interest. Clients who wish to short a minimum of $50,000 of a hard-to-borrow security and are willing to pay a fee to cover the cost of borrowing those shares, may contact Securities Lending at ... to determine the fee amount.
Last edited by MnD on Thu Dec 24, 2015 10:34 am, edited 1 time in total.
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691175002
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Re: Shorting stocks during a crash?

Post by 691175002 »

Obviously shorting stocks while during a bear market will be profitable, but if you can identify bear markets before they happen you will be enormously rich regardless of what investing strategy you pursue. Borrow costs on individual stocks are pretty stable outside of small/low liquidity stuff (unless you are retail).

The first major difference between being long and being short is that a long can only lose their invested capital whereas a shorts losses are not capped. It is rare for a stock to double or triple in a short period of time, but it does happen and many of the most attractive shorts are surrounded by speculation or are potential buyout targets.

The second major difference is that losing shorts become larger (as the stock is increasing in value) and winning shorts become smaller. If you are wrong and a shorted stock goes up it will start to represent a larger part of the portfolio. You are then forced to either lock in losses to keep the position size constant, or do nothing and take on considerably more risk.

That second point tends to do the most damage to managers who are used to long-only portfolios. Many people like to "wait things out" or "average down" when a position starts to move against them, but if you try that on a short you are suddenly sitting on a huge unrealized loss and the position is 2-4x its original size.

Options tend to be different in practice. Even though their "value" is derrived from the underlying, returns are also generated by many other risk factors.
hbgpharmd
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Re: Shorting stocks during a crash?

Post by hbgpharmd »

As others have said, a lot of luck is required to profitably time a short position during a crash.

The market timing aspect aside, shorting stocks does present a lot of hassle factors, as well as unique risks. I agree with bigred77 that buying put options are a better way for the non-professional to profit from declining prices...your maximum loss is know ahead of time, and you're not charged a borrowing fee for each day that you hold the position.
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David Jay
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Re: Shorting stocks during a crash?

Post by David Jay »

Cattle Futures

;)
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EarlyStart
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Re: Shorting stocks during a crash?

Post by EarlyStart »

qwe7791 wrote:I know shorting stocks during regular bear markets can be profitable, but highly risky. However, is the risk substantially decreased during crashes such as in 2008-2009? From my perspective, if I short at a high price during a crash, I'm most likely going to see stock prices dwindle over a period of time unless the stocks I'm shorting somehow bounced back up during a crash. Is my thinking flawed?

And I'm definitely not going to try it, but this idea just popped up in my head and I was just super curious. Thanks for the responses so far! :)

It's actually more risky during a "crash" period because the implied volatility component of options prices will fluctuate more dramatically. In other words, the volatility of volatility will likely be a lot higher.
tim1999
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Re: Shorting stocks during a crash?

Post by tim1999 »

I think by the time most people realize a crash is occurring, the bulk of the decline has already occurred.
lee1026
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Re: Shorting stocks during a crash?

Post by lee1026 »

Because there are so many people trying to do it, you will pay a premium to get stock on loan-- at least I imagine so.
I don't think this is true, at least for things like indexes. Even in 2008, shorting the S&P remained easy.
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Re: Shorting stocks during a crash?

Post by sawhorse »

Instead of shorting, which can lead to unlimited losses, you can use put options that limit your loss to what you paid. You can also use inverse ETFs, but your choices are very limited.

It's not always possible to short a stock. Many brokerages won't let you short certain stocks, mostly those with low volume. In addition, for stocks they do allow, if too many people are trying to short the stock at that time, your order will be rejected.

Never but stocks, long or short, on leverage.
Last edited by sawhorse on Thu Dec 24, 2015 5:09 pm, edited 2 times in total.
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arcticpineapplecorp.
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Re: Shorting stocks during a crash?

Post by arcticpineapplecorp. »

The sorriest part about Joe Campbell--the dude who shorted and lost is this:
"I will pay [e-trade] and be back trading...only with stop sets this time. What an expensive lesson that was."

http://www.zerohedge.com/news/2015-11-1 ... und-106000

Doesn't sound to me like he's learned much of anything, if he's gonna "be back trading."
It's "Stay" the course, not Stray the Course. Buy and Hold works. You should really try it sometime. Get a plan: www.bogleheads.org/wiki/Investment_policy_statement
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Re: Shorting stocks during a crash?

Post by sawhorse »

arcticpineapplecorp. wrote:The sorriest part about Joe Campbell--the dude who shorted and lost is this:
"I will pay [e-trade] and be back trading...only with stop sets this time. What an expensive lesson that was."

http://www.zerohedge.com/news/2015-11-1 ... und-106000

Doesn't sound to me like he's learned much of anything, if he's gonna "be back trading."
I'm surprised he was allowed to short a penny stock. TD Ameritrade, Merrill Edge, and TradeKing don't let you short them.

The stock dropped back down to 0 and is being officially delisted. Does he still owe them?

EDIT: I call BS on this. Etrade does not allow shorts below $5. This guy claims to have shorted at $2.
Last edited by sawhorse on Thu Dec 24, 2015 5:30 pm, edited 1 time in total.
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ogd
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Re: Shorting stocks during a crash?

Post by ogd »

qwe7791 wrote:Is there such a thing? I was reading over shorting stocks today and I was curious if that's possible. Since so many people are probably selling their shares like crazy, wouldn't the person who short stocks make huge profits during this time or is shorting restricted during these types of situations?
Don't do it under any circumstances. It's downright foolish.

Here's a simple argument: investing in stocks has an expected return of, say, 6-7%/year. Shorting has an expected return of -6% to -7% / year, probably even less because of the chance of being marging called at the worst time. That's a gap of 12%+/year in expected returns that you're hoping to bridge with your market timing skills just to break even with a pedestrian stock investment. That simply ain't gonna happen. You are not that good -- look outside the house and notice the missing yacht that would be typically bestowed upon Wall Street professionals of far lesser ability than 12% extra / year.

In the fund business we have market timing funds managed by full time traders with economists and mathematicians on staff, who try to bridge the much smaller gap of ~4% returns between stocks and bonds ("the returns of stocks with the risk of bonds"). In practice they fail miserably and most of them are worse off than if they did nothing at all. You, armed with a newsletter and a graph and perhaps an hour a week, have set yourself a handicap of 12%. Right. Don't do it.

[If you're inclined to say that the "expected return" at certain times is not that, e.g. "at the top before a crash" -- that determination too is part of the market timing skills that I'm arguing you -- or anyone, really -- don't have.]
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Phineas J. Whoopee
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Re: Shorting stocks during a crash?

Post by Phineas J. Whoopee »

sawhorse wrote:...
The stock dropped back down to 0 and is being officially delisted. Does he still owe them?
Yes. He borrowed from his broker, couldn't, or at least didn't, meet a margin call, accordingly they closed his position, thereby realizing a large loss, and owes his broker every cent. Remember, shorting has limited upside but unlimited downside.

If you borrow money to buy a hot rod, for example, but then it's repossessed because you missed a payment, the remaining part of your debt won't be erased just because the next owner totals it.

PJW
Last edited by Phineas J. Whoopee on Thu Dec 24, 2015 5:55 pm, edited 5 times in total.
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JoMoney
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Re: Shorting stocks during a crash?

Post by JoMoney »

qwe7791 wrote:Is there such a thing? I was reading over shorting stocks today and I was curious if that's possible. Since so many people are probably selling their shares like crazy, wouldn't the person who short stocks make huge profits during this time or is shorting restricted during these types of situations?
There are some restrictions that are in place, and sometimes shorting can suddenly be restricted.
During the financial crisis of '08-'09 there was a lot of debate about how the 'uptick rule' ( https://en.wikipedia.org/wiki/Uptick_rule ) had served the market well for almost 70 years, but was removed in '07 and suddenly catastrophe. There were accusations that some hedge funds were looking for weak spots of poor liquidity and flooding them with sell order driving prices even further down (or 'up' for the short sellers).
There were other accusations of illegal naked shorting of stocks that didn't exist (shares sold short must be borrowed, you can't legally create new non-existant shares for the purposes of selling short). But there are people who say they did the equivalent legally using the futures market:
https://www.youtube.com/watch?v=GOS8QgAQO-k
Last edited by JoMoney on Thu Dec 24, 2015 5:34 pm, edited 1 time in total.
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sawhorse
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Re: Shorting stocks during a crash?

Post by sawhorse »

nisiprius wrote:In order to short a stock, you usually need to sign a special agreement with the brokerage in which you put your signature on the record as saying that you are perfectly happy with the possibility of unlimited loss. If you've signed one of those agreements, then you can short an S&P 500 ETF like SPY just as easily as you can short any individual stock.
Unlimited losses are theoretically possible for any stock, but how realistic is it that a mega cap will triple in one day? For a megacap to rise 25% in one day is very rare, and chances are it'll come down a little in the following days. If you have an exit plan at 35% and have enough cash to cover such a loss, it's not as risky as it is in theory. For SPY, I'm not sure it's even gone down 15% in one day.

I would never trade, short or long, using leverage. And I'd never short penny stocks, nor will brokerages let you.
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Phineas J. Whoopee
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Re: Shorting stocks during a crash?

Post by Phineas J. Whoopee »

sawhorse wrote:... And I'd never short penny stocks, nor will brokerages let you.
Perhaps not, but as you noted earlier in the thread the stock has been delisted. If it were a penny stock at the time Campbell made his trade it wouldn't have been listed in the first place, and therefore couldn't be delisted later.
PJW
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JoMoney
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Re: Shorting stocks during a crash?

Post by JoMoney »

^ Believing that it won't happen because it hasn't happened is specious. Huge fluctuations are entirely possible, but somewhat mitigated in how fast they can happen because of 'circuit breaker' rules.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
sawhorse
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Re: Shorting stocks during a crash?

Post by sawhorse »

Phineas J. Whoopee wrote:
sawhorse wrote:... And I'd never short penny stocks, nor will brokerages let you.
Perhaps not, but as you noted earlier in the thread the stock has been delisted. If it were a penny stock at the time Campbell made his trade it wouldn't have been listed in the first place, and therefore couldn't be delisted later.
PJW
The SEC defines a penny stock as any stock below $5. They can be stocks listed on the exchanges.

http://www.investopedia.com/ask/answers/03/072503.asp
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Phineas J. Whoopee
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Re: Shorting stocks during a crash?

Post by Phineas J. Whoopee »

sawhorse wrote:
Phineas J. Whoopee wrote:
sawhorse wrote:... And I'd never short penny stocks, nor will brokerages let you.
Perhaps not, but as you noted earlier in the thread the stock has been delisted. If it were a penny stock at the time Campbell made his trade it wouldn't have been listed in the first place, and therefore couldn't be delisted later.
PJW
The SEC defines a penny stock as any stock below $5. They can be stocks listed on the exchanges.

http://www.investopedia.com/ask/answers/03/072503.asp
I was hoping to avoid mentioning this.
sawhorse wrote:...
EDIT: I call BS on this. Etrade does not allow shorts below $5. This guy claims to have shorted at $2.
The MarketWatch article, the first one linked upthread, disagrees with you:
MarketWatch, quoting investor Joe Campbell, wrote:...
“I was holding KBIO short overnight for what I thought was a nice $2.00 fade coming," ...
Campbell does not claim to have shorted at $2 as you wrote, although in your defense the CNN article misinterprets his thinking the stock would go down by $2 overnight as his having shorted at that price. I can see how a journalist on a tight deadline might make such a mistake, or even an editor on a still tighter deadline.

MarketWatch directly quotes Campbell. CNN does not.

He does not say he shorted at two. The premise of your reasoning is incorrect, although the error is understandable given the conflicting sources.

PJW
ccieemeritus
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Re: Shorting stocks during a crash?

Post by ccieemeritus »

If you know what the market is going to do tomorrow, you can (usually) make money.

For once I know exactly what the market is going to do tomorrow! Woohoo! Sadly I cannot make money because the market is closed tomorrow. ;-)

I have no idea what the market will do Monday (the next day it is open). So I will continue to hold index funds for the long term.
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