Why betting on prices falling isn’t as easy as it looks.
Hindsight is a beautiful thing, particularly when it comes to predicting market crashes and I am seeing a lot of chatter on social media asking “well, why didn’t you just go short?”. For those readers who are not familiar with the practice of being able to sell something you don’t own, don’t worry so much about the complex mechanics of stock lending, financial derivatives and margining. The simple fact is, that in today’s wonderful world of investing, it is just as easy to bet on prices rising (long) as it is on prices falling (short).
However, there are a few intricacies that makes one more risky than the other and that has to do with mathematics. If you buy something at 100 and it goes to zero, you lose 100%. If you short something at 10 and it goes to 100, you lose 900%. That makes getting your entry and exit points right critically important. Lest we forget that none of us have a crystal ball and timing the markets remains to be the proverbial female dog.
But let’s look at the events of this crash in slow motion to really understand why it is so difficult to bet on prices going down. Remember January? China had just broken the news that there was a virus circulating and things were bad. Emerging markets sold off 15% almost instantly. Time to go short then, eh? Well, even the most ardent trader would have lost their nerve, as markets ripped to all-time highs over the next three weeks. If you had sold the markets at that time, your losses would have been more than 25%.
Now imagine, if you are a fund manager and you made a living trying to beat the markets. Nobody is going to fire you if you underperform by a percent or two. How do we know this? Because 99% of fund managers underperform the market and investors don’t seem to care. So, imagine taking a view on the crisis, getting it wrong and losing 25%, whilst everyone else is making money. Every client would run for the hills.
To be honest, no one understood why equities went up 400% from the lows in March 2009 to the highs in February 2020, but if you had shorted the market back then, you would have gone bankrupt many times over. So, ignore all the pundits who are now shouting from the roof tops “I told you so”. In German we have a saying that even a blind chicken will eventually find a piece of corn, which loosely translates into English that even a broken clock is right twice a day. Do you really want these people managing your money?
Where does this leave us? If you had sound risk management in place before the crisis, then you will survive these events and you can take advantage of some of the greatest investment opportunities of the century when this thing is over. If you feel that you can time the markets perfectly and you are blessed with the gift of foresight, I suggest going to the casino and betting it all on black. Better odds, lower costs, and you may even get a free cocktail