Shorting the Market

This is a recent email I sent to Bill Fleckenstein's Ask Fleck with regard to shorting:

"Bill, I have seen quite a few emails to you lately lamenting the fact that their shorts are not working in the face of a couple days' rally. My guess is that their short positions are too big relative to the size of their portfolios, hence are creating anxiety in the face of only a couple days of market rallies.In my opinion, either they need to constantly watch their large short positions miniute by minute and "dance around" (to use your phrase) it if necessary, or, if they want to follow your opinion (not advice, of course) as an investor and not short-timer the market, then they need to keep their position size down to a level they can sleep at night and be patient and listen to how the market "talk" to them, and "talk back" via stop losses. People who read Mamis' "When to Sell" know what I'm talking about.

Case in point, I started shorting NFI, NEW and LEND in modest sizes in spring of 2006 and took lots of small losses along the way, and I frequently re-entered my shorts at a lower price. Call it "risk management" if you want. In other words, I was "wrong" throughout 2006 on the subprimes. But I was never in a position where a wrong move by the stocks (as it frequently happens with these "fantasy" stocks) would mortally damage my portfolio. As you know, patience was paid off starting in February: Six weeks' of sudden favorable (i.e., doown) movement more than made up for the small losses and resulted in huge gains for my portfolio.

But that's just how market works: it does not do your bidding at _your_ timetable. For those interested, Jonathan Hoenig at Smartmoney.com also wrote quite a few articles about position sizing. His archived artcles at the website are free. But a lot of it is simply common sense and keep your own greed and fear under control. "