Well, here we go again. On a gray Thursday morning, the market is tanking as I write. The trading screen is a sea of red as risk appetite recedes.

  Earlier this week, Macro Trader subscribers received the following commentary:   The charts tell all. If sentiment fully shifts, it will show up in the charts and newly established downtrends will take hold. Bulls need to take a stand very quickly or they will cede control to the bears.   A test of conviction is thus coming up as a market inflection point develops. Is the current juncture a buying opportunity, and thus a place to cover shorts and add to longs? Or is it merely a pause before the downtrend continues in earnest? Could it be a “buffalo” market, in which the charts turn but fail at new highs again? 

Based on a combination of overly high valuations, broken uptrends, and historical trading patterns in which hope-driven rallies are followed by extensive declines, Macro Trader is biased towards potential short entries on the major indices on signs of further rally failure.   This leads to a question. Should you learn how to go short?   Plenty of practitioners get by without giving the "dark side" a second thought. The vast majority of mutual fund managers, for example, couldn’t go short even if they wanted to. (They are restricted by very tight rules.) The money management biz even has a descriptive term, “long only,” that means exactly what it sounds like. A fair number of investors will never short a thing in their entire careers.   In your humble editor’s opinion, the answer to the question is still a qualified “yes.” Investors in general should learn how to short... or at least consider the merits. Even if one never pulls the trigger, one might be better equipped as a market participant in learning how shorting works.     A Poker Analogy   To highlight the benefits (and dangers) of shorting, let’s talk poker for a minute.   Poker is an excellent training ground for traders and investors. To win at poker, you have to assess odds and probabilities. You have to make decisions with incomplete information. You have to constantly observe your opponents, noting their playing styles, betting patterns and emotions. And you have to keep a firm grip on your own emotions, resisting the urge to chase subpar opportunities or otherwise go on “tilt.”   There are many varieties of poker. The most popular variant these days (as you surely know) is Texas Hold ‘Em, or just “Hold ‘Em” for short. The game of Hold ‘Em furthermore comes in two flavors, “Limit” and “No Limit.”   In Limit Hold ‘Em, the size of the bet is always capped. There is a maximum amount you can wager at any point. But in No Limit, as the name implies, there is no cap on betting size. You can raise as much as you want, up to the full amount of your chip stack. (That’s called going “all in.”)   No Limit Hold ‘Em is considered the more aggressive and nuanced game. There is more risk involved... more strategy to consider... and greater potential cost in making a mistake.   Limit Hold ‘Em, in contrast, requires a lot less strategy because of the restrictions placed on betting size. It is harder to mess up because your range of strategic options is limited (and so are your opponents’). Because the bet size is always capped, you can’t protect your hand, build a pot, or set a trap for your opponent the way you can in No Limit.   With no effective way to push them out, Limit Hold ‘Em players are known for constantly staying in pots until the end, trying to hit their long-shot draws. (This is why Limit is oft nicknamed “No Fold ‘Em Hold ‘Em.” The players rarely fold.)   By way of this analogy, learning how to go short is like moving up from Limit to No Limit. It’s a bigger game, the stakes are higher, and more strategy is required. But if you learn to play correctly and well, there is more profit potential in it too. A strong No Limit player can stand out from the pack far more easily than a Limit player can. The skill-to-luck ratio is higher, giving skill a broader advantage. And with experience and discipline, there are ways to limit the risk.   For a dyed-in-the-wool No Limit player (such as yours truly), there is no going back. After you’ve learned and internalized the higher-level strategies, playing Limit is a downgrade... like being a kickboxer and not being allowed to use your feet.     The Benefits of Versatility   The transition from Limit to No Limit – and it is almost always in that direction, rarely the reverse – is akin to the move from being a “long only” investor to one who goes both long and short.   Such a move is not for everyone. Just as there are plenty of poker players who would never dream of trying No Limit, there are plenty of investors who would never dream of going short.   There are many reasons long-only investors cite in defense of this one-way orientation. We can detail some of the objections later, but most of the anti-shorting reasons boil down to two general complaints:                         • Shorting Is Dangerous.             • Shorting Is Too Hard.   There is also the implied complaint of having to learn something new, which inevitably requires making mistakes along the way. A sufficiently steep learning curve can be hazardous to the ego.   And yet, the profit potential in learning how to short – and the capital preservation too! – makes such a move worth considering. (Amusingly, shorting has worth as a skill in part because so few investors are willing to try.)   Knowing how to short has another side benefit. It means you don’t have to feel bummed out and helpless when markets go down for months at a time, as they still sometimes do. The late great bull market of 1982–2000 trained investors to think stocks more or less move in one direction only. But now we have traded in the shiny happy conditions of the ‘80s and ‘90s for the roller coaster conditions of the ‘30s and the ‘70s. Bull and bear moves can run for very long stretches.   As the great trader Jesse Livermore once said, “There is only one side of the market and it is not the bull side or the bear side, but the right side.” To be long only, though, is to only have access to half the equation. Better to be flexible, avoiding bias toward one direction or the other.   Then, too, there are the benefits of balancing out a portfolio of high conviction long-term investments with offsetting short positions. This is called “hedging,” and it is the original idea behind the term “hedge fund.”   If you have a number of high-conviction holdings and see a storm coming, it isn’t always necessary (or even desirable) to dump those positions over the side. Instead, the added versatility of going short allows one to mitigate downside market risk, or even profit from it on the whole, while still maintaining a long-term investment stance.   Again, this is a controversial area. Some will warn that shorting is not wise... that only “professionals” should attempt it. (These are the same individuals who by and large advise putting your money at the blind mercy of index funds, but that’s a rant for another day.)   Before we go further, a quick survey. Are you interested in learning more about shorting? If you already know how to short, how often do you do it? Are you equally comfortable with both sides of the market (or would you like to be)? Any specific topics you would like covered, or insights of your own to share?   We could do a lot more digging on this topic, but only if the readership finds it worthwhile. Put in your two cents here: This email address is being protected from spambots. You need JavaScript enabled to view it.