Monthly Archives: August 2016

Valuation, Timing and Emotion: Why Shorting the Market Index Was Harder Than I Thought

Shorting the index with ETFs

Last year in May, I sensed that a bear market was coming. So I shorted the market with inverse ETF SH and 2X leveraged inverse ETF SDS. I made decent profit in the panic selling in Jan/Feb 2016.

But I overestimated the bear market. The rally continues into the spring, my profit evaporated and I added more short position. It quickly became a loss. I briefly had a chance to break even, thanks to Brexit panic. I missed the chance with more wishful thinking. Soon all major indices made historically new high. I had to stop loss with substantial loss.

This is a new lesson I learned that shorting market index is hard. It is hard to value the security ETF; it requires perfect timing; and strong emotion makes me impossible to make the right decision.

Valuation

When I long a stock, I do my due diligence to understand its business. For biotech stocks, I learn about its disease market and the candidate drug. How does it address any unmet medical needs? How about its competitors? Then I do a rough financial analysis to assess its value. I buy when it is significantly undervalued.

However, when I short the index. Despite the price tag, there is no business represented by the ETF SH or SDS. It doesn’t create any product or service or value for the society.  It is purely dependent on the level of index, which can be overvalued or undervalued based on market conditions.

I thought I can short the overvalued market. But the problem is, overvalued market can go even more overvalued. Then “timing” comes into play.

Timing

When I long a stock, as long as I can reasonably estimate its value and buy when I believe it’s undervalued, I don’t need to be perfect in timing. Even if I entered too early in a down trend, all I need to do is be patient and wait. It will have its prime time and shine with its value back in play.

However, when I short the index and valuation is hard, I have to be perfect in timing. In short term, time decay is significant. In long term, all short ETFs will eventually go zero. There is no way I can hold it forever. I HAVE to catch the wave. I have to enter when market is high and exit at low, preferably at extreme panic.

I was enjoying 20% profit with my SH/SDS in January 2016. My goal was to exit when $VIX goes above 35. But it didn’t happen. Then my profit becomes loss in the spring.

Emotion

When I long a stock, I know its value, and I also know timing is not so important. I have peace of mind to be patient and make relatively calm decisions.

However, when I short the index, I don’t its value and have to be perfect at timing in the same time. Emotion and ego surge to a high level, either when I am right or wrong. It’s pure speculation in mind. I check every technical indicators and market news constantly to give my wishful thinking a rootless (no value) support.

Am I wrong again? How could I turn profit into loss?

Such strong roller coaster emotion is bad for decision and my health. It is not worth it.

[Further reading]
10 Reasons You Should Never Short a Stock or Index Fund