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I’ll get right into it: many of my readers had some questions about my
piece earlier this week on
shorting Italian bonds to profit from the country’s debt
crisis.
This isn’t the typical ‘income story’ that government issued bond
investors expect to read. But it’s important that ALL bond investors
understand the risks that come with buying government issues securities;
especially when that government recklessly spends money.
The premise: Italian bond yields are on the rise. When yields rise, bond
prices plummet. So we can make money shorting bond prices.
As I wrote: “The easiest way to short Italian bonds is to sell shares
of the PowerShares DB Italian Treasury Bond ETN (NYSE:
ITLY).”
Among the questions I received, I also got some very interesting (and
heated) commentary from an Italian reader.
He wrote:
“You are shorting = slaughtering us.you do NOT short the UK, your
friendly relatives after all…this is what I call the anglo-saxon mafia,
the white collar one.”
So before I get into the questions on shorting, I’d like to clear up one
BIG misconception about shorting – which my Italian friend seems to
believe in wholeheartedly.
The misconception? That shorting causes prices to fall.
It’s a total myth. It’s no truer than the idea that buying an asset makes
prices rise.
No one would seriously claim that buying forces prices up. But even the
mainstream financial media can’t avoid this myth. Short-sellers are seen
as the cause of falling prices.
They’re called vultures, assassins, ninjas, predators, leeches and slime
balls. People FEAR short sellers. But as with all things that people
fear, it’s only out of ignorance. Most people just don’t understand how
short selling works.
But it’s an incredibly valuable tool that should be in every investor’s
toolbox – even bond investors’.
Being a long only investor is like having a car that doesn’t go in
reverse.
The market rises and falls. You can make money when it rises, just as you
can make money when it falls. Don’t limit yourself to half of the
opportunity.
So, here are the reader questions:
“I recently read your article How to Profit From Italy’s Fall. In the article you
said to sell PowerShares DB Italian Treasury Bond ETN (NYSE:
ITLY). I am new to the investment world and would like to know
what you mean by “sell.” Are short investments meant to make a quick
profit? And is this a good investment for someone who is new to the
market and has little money? – GB”
GB, normally if you think a stock or other investment will go up in
price, you’ll buy it now – then sell it later once it has gone up in
price.
But shorting is the opposite. You believe something will fall in price,
so you borrow shares (from your brokerage) to sell now.
Then you buy them back later (to repay your broker the borrowed shares)
when the price is lower.
It’s kind of confusing at first – but think of it this way: you
only make money when you remove your exposure to an investment.
But instead of buying low, then selling high, you’re selling high, and
then buying back low. At least, that’s your goal.
Selling high is the key. It doesn’t matter when you do it, as long as
your selling price is higher than your buy-back price.
As for your question about the duration of a short, yes – they do tend to
be shorter term investments. But that’s only because investments have a
general tendency to fall faster than they rise. And, ironically, that has
everything to do with the fact that most people DO NOT short stocks. So
when an asset is falling there’s a tendency for “long” investors to hold
and pray. Eventually, they sell, but only after the asset already fell
hard.
And for your last question, I know that most investment advisors will
probably have a coronary when I say this – but yes, shorting investments
should be something that new investors use – for the simple reason that
it’s somewhat easier to find assets that are likely to fall.
Shorting is just as easy as and no more risky than buying a
stock.
Instead of selecting “buy to open” or “buy” in your online brokerage, you
select “sell to open” or “sell.” You’ll need to open a margin account to
sell short.
It’s possible that you won’t get filled. It depends on your broker, the
volume of available shares and a few other factors.
But if you’re unable to short, I’d suggest calling your broker and asking
them what you need to do in order to be able to.
Don’t let anyone tell you that you shouldn’t short stocks.
Again: shorting something does not make the price
go down. And when short-sellers buy those bonds back to close the trade,
it will actually be a great relief to people who want to sell. Who else
would buy bonds after they fall 50%?
Without short-sellers, the price of Italian bonds would likely drop even
further.
Good investing,
Kevin McElroy
Editor
Resource Prospector