Short selling does not work part 2

Reader has following comment on short selling post:

walter said...

i know that people short indexes - i dont... at any rate, your headline should read "short selling indexes does not work" and not "short selling does not work"

obviously, depending on smart stock selection, shorting can work, just like going long some stocks during a bear market, dont you agree?

The study specifically refers to stock. All quanti studies on stocks show the same thing.

For any given time period if you have to choose between long or short strategy, long strategy significantly outperforms short.

When you find a good short you have to ask a question , if I hold this for a year as against a choice of long stock , longs will do better. The opportunity cost of shorting is what one should consider.

Lets consider the last one quarter as example and look at it : there were 183 stocks (after removing thinly traded stocks) down 25% or more in last 65 days with 18 stocks down 50% or more. Now if you were very good stock picker and managed to also find stocks to short in your chosen equities, then you had an opportunity to make max 79% ( on the worst performing stock)

For the same period there were 1173 stocks up 25% or more in 65 days with 274 stocks up 50% or more and 74 stocks up more than 79% plus (as against only 1 in short universe)There were 10 stocks up more than 150% and the best performing stock was up 670%. So for 1 79% return stock on short side there were 74 opportunities on long side. Plus the potential for maximum profit was 670% as against 79% for short side.

This is just an example, but the reason why long only methodologies work even after staying out of market during bear market, is because of this significantly skewed long vs short returns.Stocks have potentially unlimited upside but downside is limited.

So all you need to trade successfully is a long methodology. Marry that with risk management and it will automatically keep you out of bear markets ( due to use of stops) and you will beat the pants of any expert short seller. Once you start analysing markets quantitatively or data mining, this is the first overwhelming thing which hits you: that long strategies have overwhelming edge over short.

The practical implication of it is very clear, put all your efforts in to designing long strategies. Use some market filter or risk management methodology to stay out of bear market and you are ahead of the game. So even though I have studied and designed short strategies that work, my overwhelming preference is for long strategies.

This is one of the reason, even if you have to follow a market guru, at least follow a bullish guru, following perma bear gurus is a way to poor house. When you understand and internalise this fact, you will also realise any guru claiming never to buy 52 week low is completely ignorant of how markets work. You will understand why both set of strategies, growth and value work(because they are long strategies).

Even a poorly designed long strategy will outperform a short only strategy. The stock market game is rigged in the favor of long strategies. Some people understand this some do not. Some people spend years on street and do not.

The market is one huge long biased conspiracy.

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