When the market begins to break down and one or more of our market timing indicators turn negative, we often get a few inquiries about shorting. Do we short? Why or why not? What are the advantages or disadvantages of shorting, especially with all the inverse ETFs in existence today?  

In general, we do not go short (or bet against the market with ETFs) in the Model Portfolio, and the reason is simple: It’s extremely difficult to make good money shorting unless you’re an active trader. If you are, more power to you. But since we aim for intermediate- to longer-term gains, it only makes sense to attempt shorting if you’re in a bear market … which our Two-Second Indicator and Cabot Trend Lines tell us is not the case today.

Also, in our various studies and research over the years, we haven’t heard of many investors making a boatload of money on the short side. The reason is simple math: When you’re investing in companies with revolutionary new products and services, a stock can rise 50%, 100% or more if you catch a real winner and remain patient. When shorting, however, your profit objective is usually much smaller—20% to 25%—mainly because sharp rallies come during downtrends and usually wipe away a few weeks’ worth of gains. Instead of letting winners run, you need to take profits quickly! Given that a loss limit is probably 10% or 15%, shorting is not a very attractive reward-to-risk ratio.

Last but not least is the psychological factor: Very few people are able to “play” the market constantly, day in and day out, following a bunch of stocks and earnings reports, researching stories and so on; months and months of action can be draining. And so, during any downtime, it’s often beneficial to take a step back, re-evaluate what stocks and sectors are doing best, and get ready for the next upturn.

Of course, we don’t pretend to have the sole rule book on investing; we’re sure many of you use short-related instruments (ETFs, options, etc.) with great success. But our point is that, right now, when the market is likely at worst in an intermediate-term correction (not a new bear market), your best move is to focus on holding some cash and preparing for the next major upmove … and the opportunities that come with it.

Click here for information on Cabot Market Letter or Cabot Top Ten Weekly.

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