How does the short circuit work?
The short selling strategy has been very popular since the bubble.
explosion of technology stocks in 2000. Shorting a stock is
simply a bet that the stock price will fall.
An investor can sell a stock that he does not own for
borrow shares from brokers. The investor can sell the
shares first and then repurchase the shares at a later time. Tea
The investor can make a profit if the price of the shares he sells is
higher than the price he or she will buy back later.
Short sale strategy for value investors? in appearance,
the short sale strategy should work well with the most value
investors The central task of a value investment is
calculate the intrinsic value or the value of a share in
in order to identify bargain stocks that are traded at
discount to their intrinsic values. If a successful value
the investor can buy shares cheaply based on their intrinsic value
value, why not sell an overvalued stock short? At the end,
The method for calculating the intrinsic value is the same if
the stock is overvalued or undervalued.
However, if you carefully read the value investing books
of Benjamin Graham, the father of value investing, can
find very little information on the short circuit. We also know that
Warren Buffet himself does not use the short circuit method. Then
Why is the short sale strategy not used by 2 higher value?
investors in history?
Short selling requires a higher degree of diversification
Mutual funds are known to have an extremely diversified structure
portfolio of millions to thousands of shares.
Many successful value investors invest in
stock portfolio with adequate diversification. In the book
Intelligent Investor Chapter 5 entitled “The Defensive
investor and common stock,” preached Benjamin Graham
“adequate diversification” from 10 to 30 stocks, but not
“overdiversification”. Warren Buffet was also known
invest in a portfolio of fewer than 20 – 30 stocks for your
hedge fund in previous years and for his firm Berkshire
Hathaway. Charles T. Munger, the second Berkshire man
Hathaway, and himself a huge billionaire investor,
was also known for making an even more concentrated bet than
Warren Buffet when he was alone running his own hedge fund
before joining Berkshire Hathaway. my past investment
performance in the Blast Investor Real-time Plus newsletter was
also obtained with a concentrated portfolio of around 10
actions too.
However, this type of common concentrated portfolio in value
investing world would not have adequate diversification with
shortening strategy. To illustrate this point, I put the following
2 hypothetical cases to compare a typical value only long
investment portfolio and a combined short- and long-term portfolio.
Case 1 – Long Only Value Investment Portfolio
Table 1- Portfolio 1, Only Long Portfolio
Stock Long or Short $ USD per stock position
1 length $10,000
2 lengths $10,000
3 lengths $10,000
4 lengths $10,000
5 lengths $10,000
6 lengths $10,000
7 lengths $10,000
8 lengths $10,000
Long $10,000
Long B $10,000
Total capital $100,000
Table 1 is a hypothetical fully invested portfolio with 10
stocks. All 10 stocks are bargain value long positions
stocks. Suppose that during the 2 years, the price of shares 1 to 8 remained
flat with no profit or loss, and stocks A and B each lost
90% of its value in the first year, and then not only
recovered all losses in the second year and actually
double the original ticket price. Table 2 is
performance of portfolio 1 for these 2 years:
Table 2 – Performance of Portfolio 1
Initial Stock Year1 Year2
At $10,000 $1,000 $20,000
$10,000 $1,000 $20,000
Portfolio1 $100,000 $82,000 $120,000
Portfolio1 Performance NA -18% 46.34%
90% of the loss in 2 of 10 portfolio stocks did not kill the
Overall 2-year performance of Portfolio 1. In fact,
Portfolio 1 still enjoyed an overall 20% gain over the 2 years.
Box 2 – Long and Short Wallet
Table 3- Portfolio 2:
8 long actions, 2 short actions
Stock Long or Short $ USD per stock position
1 length $10,000
2 lengths $10,000
3 lengths $10,000
4 lengths $10,000
5 lengths $10,000
6 lengths $10,000
7 lengths $10,000
8 lengths $10,000
X Shorts $10,000
shorts AND $10,000
Total capital $100,000
Table 3 is a hypothetical fully invested portfolio with 10
stocks. All 8 shares (stock 1 to stock 8) have the same length
bargain value stock position, and Stock X and Stock Y
They are short positions. Suppose that for the 2 years, 1 to 8 stocks
the price was stable with no profit or loss, and the stock price
X and Y increased 10 times each in the first year, and then
not only did he lose all the winnings in the second year and actually
crashed further and was cut off in the middle of the original inning
price. Table 4 is the performance of portfolio 2 for this 2
years:
Table 4 – Performance of Portfolio 2
Shares Initial Equity Year 1 Equity Year 2 Equity
X short position $10,000 -$90,000 $15,000
And short position $10,000 -$90,000 $15,000
Portfolio2 $100,000 $0 (delete) $0 (delete)
Portfolio2 Performance NA -100% -100%
Although the investor correctly predicted that the stock price
of X and Y would fall in 2 years, the first year increased by 10
times in the price of shares of X and Y triggered the margin call in
portfolio 2. The 2 short positions of X and Y ended the
the whole portfolio 2 so that the portfolio never had a chance
to make a profit in the second year of the dramatic fall of X and Y
market price.
Market Timing and money management
Although the above -90% loss and hypothetical 10 times increase
cases are not common, this kind of wild ride in stock
market happened. The price of a share changes from $1 to $10 or
$10 to $1 was even less rare in small caps or micro caps
market.
A prudent investor certainly cannot rule out such
opportunity in portfolio management. long term oriented
Value investing with 10 stocks can certainly support this
type of losses in case 1. However, the same exchange rate
would have no chance of surviving for the short sale strategy as
is shown in case 2.
To avoid elimination with a short strategy, the investor has 2
options:
The investor must have a more diversified portfolio,
possibly with hundreds or thousands of shares as a
typical portfolio of diversified mutual funds.
Gold Investor would participate in the gold market in the short term
time for the investor to sell short at or near the top to
avoid eliminating the risk.
Neither of the above 2 options is attractive to a true
successful value investor. First of all, bet concentrated
without excessive diversification is one of the key reasons for
high performance. With millions or thousands of shares
under management, a portfolio with a short strategy would be
as mundane as a typical mutual fund portfolio in terms of
performance. Second, the value investing method is price.
long-term oriented investment method, which in itself is
odds with any market timing or short-term trading strategy.
Certainly, there are successful investors who use short positions
stock market strategy. However, here is my last 5 cents.
like below:
High-value investors like Warren Buffet and Ben Graham
I don’t cut, it’s not necessary either.