TimingCube - Short selling explained - short selling,uptrend,equities,market downturns,broker

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Signal Update

Current Signal Performance as of 11/07/2003
Signal Type	Trade Date	Return since issued
Buy	04/03/2003	+33.75%

Cumulative Returns since First TimingCube Live Signal (06/18/2001) as of 11/07/2003
Long Only	Long Only with Margin	Long & Short	Long & Short with Margin	Buy & Hold
+85.80%	+204.54%	+243.46%	+824.55%	-16.44%

Note: Performance and Returns above are obtained by using QQQ as the investment vehicle.

Market Update

The U.S. economy keeps improving. Nonfarm payrolls jumped 126K in October, much more than the 65K increase economists expected. The August and September numbers were also revised upwards, confirming the pickup in activity. This is good news for stocks, despite the fact that both the S&P 500 and the Nasdaq Composite closed slightly lower today on decreased volume.

QQQ was up 1.28% for the week and has gained 33.75% since we issued a Buy signal after the market close on April 2. The market uptrend is still intact and our Buy signal consequently remains active.

Trend Timing School

Short selling explained

When the market is in an uptrend and we are in a Buy position is a good time to get prepared for the Sell signal which will come sooner or later. In previous Updates we've reviewed why it is critical not to hold equities during market downturns, and a quick glance at the returns of our four strategies clearly shows the performance boost that can be achieved with short selling. Regrettably, many subscribers pass-up the opportunity for higher returns because they do not understand shorting, so we will attempt to explain the technique here today (Margin trading will be discussed in a future issue).

Put simply, short selling is the opposite of "going long" or buying a stock. An investor borrows shares of stock from a broker and sells them. He is said to have a short position in that stock. The shares come from the broker's own inventory or from another customer. When the stock is sold the proceeds are credited to the investor's account. In order to make a profit the short seller hopes the price of that stock will go down so that the shares owed the broker can be replaced at a lower cost. The open position is closed at some point in the future by purchasing shares and returning them to the broker. This is called short covering. The profit on the transaction is the price at which the stock was initially sold minus the price paid for the replacement shares, minus any fees, interest and dividends. Of course, if the price of the stock went up between short and cover, you'll have a net loss.

As with most things there are costs, restrictions and risks. The costs are mostly in the form of broker fees and interest but you will also be responsible for dividends if any are paid while you are short the stock. Since you borrow the shares, you are buying on margin and you will need to open a margin account to short stocks. You will be charged interest on the loan and you are subject to the rules of margin trading. There are many restrictions on the price and type of stocks you can and cannot short, as well as SEC regulations such as the uptick rule which prevents short selling unless the previous trade was at the same or higher price. (Editor Note: On July 6, 2007, the SEC abolished the short uptick rule. See the August 24, 2007 FAQ of the Week for more details). These rules are designed to protect stocks in declining markets. The risks are mostly related to margin issues and how much can theoretically be lost on a trade. When you buy a stock outright, the maximum you stand to lose is the amount you paid for it, if it went to $0. In a short sale, since there is no real limit to how high the price of a stock could go, your potential losses are infinite. Another risk is to be "called away" at a price you don't like. Normally you can hold a short as long as you want but you can be forced to cover if the broker wants back the stock you borrowed; this is known as being "called away". This does not happen very often but is possible.
One way to simplify this and side-step many of these issues, and circumvent the no shorting in retirement accounts rule, is to instead use one of the numerous mutual funds that seek to achieve the same results - for more details see the "Our Service" page.

Many of the risks of short selling are mitigated by the rigorous Trend Timing discipline we practice and, for our own investments, we view the "Long & Short" strategy as offering the best risk/reward tradeoff. As always, you need to decide what is right for your individual situation, but you should only engage in short selling if you thoroughly understand what you are doing and what you are getting into.

FAQ of the Week

Question: How can I calculate yearly returns?

We do not favor yearly returns because they tend to be misleading and omit what may be the most significant ingredients of any wealth building system: time and the power of compounding. This being said, you can very easily calculate the yearly return from the data we provide.

The source data can be extracted from the table on the "QQQQ Results" page. Let's calculate the return for the year 1999, using the "Long & Short" strategy as an example. Note that the numbers in the example are as of the close on 11/7/2003. These numbers will change for later dates but the method, and the calculated results, will remain the same. Here are the steps:

Select "1999 (1/4/1999)" in the "Trades and Returns since" pull-down menu above the table. The Long & Short cumulative return since then is 1902.06%. This means that an investment made in January 1999 has been multiplied by 20.0206.
Select "2000 (1/3/2000)" in the "Trades and Returns since" pull-down menu above the table. The Long & Short cumulative return since then is 863.07%. This means that an investment made in January 2000 has been multiplied by 9.6307.
Therefore, the multiplier for 1999 alone is 20.0206 / 9.6307 = 2.0788. In other words, the return for 1999 is +107.88%.

Now that you know how to do it, the rest is just tedious work which we're happy to take care of. The yearly returns for all past years for which we have data are:

Year	Long Only Return	Long Only w/Margin Return	Long & Short Return	Long & Short w/Margin Return	Buy and Hold Return
2002	+6.58%	+12.58%	+62.23%	+142.29%	-37.53%
2001	+30.55%	+62.22%	+112.68%	+289.18%	-32.43%
2000	+23.59%	+49.67%	+107.32%	+278.87%	-39.12%
1999	+107.88%	+195.59%	+107.88%	+195.59%	+107.90%
1998	+105.00%	+195.76%	+125.60%	+256.48%	+85.31%
1997	+32.82%	+65.68%	+45.01%	+96.10%	+20.63%
1996	+42.83%	+80.47%	+43.91%	+82.99%	+41.59%
1995	+41.20%	+79.53%	+38.79%	+73.40%	+43.62%
1994	+5.96%	+9.89%	+10.43%	+19.15%	+1.50%
1993	+11.50%	+22.87%	+12.42%	+24.90%	+10.58%
1992	+13.05%	+26.42%	+17.22%	+35.74%	+8.88%
1991	+64.95%	+126.89%	+64.95%	+126.89%	+64.95%
1990	+23.75%	+37.21%	+58.69%	+115.43%	-10.46%
1989	+26.15%	+57.55%	+26.15%	+57.55%	+26.15%