Investing IV - Short and Long

Inspired by a reader and commentator, I will now pretend to know something about short and long positions.

I've read up on selling short previously. I had to in order to try to understand the market machinations of Eliza in The Baroque Cycle.

Having read up on the practice again just now, I must confess that I'm no closer to understanding the concept of selling short. It's really quite bizarre, and it opens up the market to all manner of tomfoolery.

If the wikipedia article on the subject of short selling is to be believed, "In finance, short selling or 'shorting' is the practice of selling securities the seller does not own, in the hope of repurchasing them later at a lower price."

I hit the phrase "selling securities the seller does not own" and I'm done. I've read the rest of the article. I understand it in general. I know that there's ways to profit from selling a stock short. All I know is I want no part of it. I also want no part of buying or selling options or trading on margin.

These things are very far removed from the simple practice of investing in a stock you believe in.

But when you invest in a stock, does that mean you believe in it for the long term, or the short term? Are you taking a long position, or a short position?

If you hear someone talking about taking a short position on a stock, it does not necessarily mean that they're going to sell the stock short (although it might).

In simplest terms, taking a short position means you think the stock is going to go down soon. So if you own it then you probably want to sell it before it does go down. When it goes down as much as you think it will then that's a good time to buy it again.

An investor saying that they're taking a short position on a stock, then, really means that they've sold it or they're selling it, but they're keeping their eye on it and will buy it again once it's gone as low as they think it possibly will.

(Technically short sellers mean the same thing, only they never owned the stock in the first place, and after they've bought back at a lower price the stock they just sold then they still won't own it. Short sellers play with other people's shares and give them back when they're done. Yes, I acknowledge that this makes no sense.)

Similarly, taking a long position on a stock means that you're going to buy it now and hold onto it for a long time, as you think it's going to go generally up for a good long while. Maybe you'll sell it, eventually. Maybe you'll keep it forever, accepting dividend checks, and eventually you'll give your long-position stock to your descendants.

Now I described my early attempts at investment back in Investing II. I bought and sold the same stock a few times in a relatively short period of time. I didn't trust that the stock would go up and up and up indefinitely, so I guess I'd have to say that I took a short position in that stock.

My investment strategy now is not that different from then, except that now when I find a company I like, I look at its fundamentals. If it has good fundamentals then I put it on a watch list with some notes as to how much to pay for it (really, how little to pay for it) and how much I want to get for it when I sell.

Because I'm going to sell it. I'm not going to keep it indefinitely.

This watch list comes in handy when one of the stocks I own rises to the point that it's time to sell.

In general, I don't take a long position in anything. The stock market is full of lemmings (many of them short-selling lemmings) and they can't be trusted to allow companies that deserve it (and only companies that deserve it) to rise in value.

So instead of buying stock in companies that I think are going to do great forever, I buy stock in companies that I think are going to do better than they're doing now.

Also, when I buy a stock through my online stock trading service at a price of X dollars, I immediately - IMMEDIATELY - turn around and put a sell order in for that same stock.

Not that I want to sell at the market rate. Oh no no no no no. I put in a Limit order to sell at no less than 200% of X dollars. Or 300% if I think it's going to do particularly well.

I can go back and modify my Limit orders later.

Let me give a real-world example: Comverge. Stock ticker of COMV. This is a stock that I've bought and sold previously. Within the last 6 months, in fact. As of this writing I have no position on this stock. That is, I do not own it. It is, however, on my watch list. (You could say I have a short position on this stock, technically.)

But as I said, I have owned it previously. I bought COMV at 11 and change. I put in a Limit order to sell at 32, because it had gone that high before and I was and am an incurable optimist.

It went down. It came back up. It never went anywhere near 32.

I revised my estimates and modified my Limit order to sell at 19.

But it never went anywhere terribly close to 19...

Meanwhile, there was some item on my watch list that had come down to the point that I wanted to buy it. And the grass is always greener, right? Or those two birds in the bush look a lot better than the bird I have in my hand, or something...

I modified my limit again and sold at a little under 14. I made something like a 24% profit. (Minus brokerage fees, so it was really a few percent less.)

Of course, it then went to $14.25 and I kicked myself, because I could have had a 27% profit...

...And, of course, if it had continued to go up to 19 or 32 then I would have been most unhappy with myself...

...But it didn't. It turns out my 24% profit was well-timed. As of this writing COMV is trading below 9 dollars a share.

It's on my watch list, and I'm staring at it.

The last couple months have been less than stellar for the markets, though. Of the stocks I own just now, all but one of them is currently worth less than I paid for them. There's nothing I own that I'm willing to sell in order to buy COMV just now. I could, of course, deposit more cash in my trading account and buy some COMV stock, but I've put all the money into the stock market that I'm going to, at least at this time.

(Readers with good memories know that overall I've lost 20% of the money I've invested. I'm not investing more until I see some evidence that I know what I'm doing.)

The one stock that I could sell at a profit? I guess I do have a long position on that one. Sort of. Can I call it a long position when I have already put in a Limit sell order? (Right now it's worth 113% of what I paid for it. My sell order is for 241%.)

I guess I just have a position in that stock. Not a short position. Not a long position. But I have a position.

We'll see how I do.