Everyone Wants To Make Money Trading the Downside – So Why Don’t They?

Fear is the path to the Dark Side. Fear leads to anger, anger leads to hate, hate leads to suffering.   YODA, Star Wars Episode I: The Phantom Menace

Remember back in in the 2008/09 financial crisis when everything was falling apart, stock and housing prices were falling off a cliff and you may have felt stuck holding the bag?  I’m sure the thought of ‘just let me catch some of this downside’ crossed your mind just a few times, but you didn’t have the courage to execute.  When the March 2009 low hit you were frustrated because you ‘knew’.  And then the stories came out – this guy made millions, that other guy made millions, all short the market.  Frustrating, wasn’t it?  To them, it was crystal clear and easy to see.  But for you it wasn’t so easy, in fact when you’re stuck long it’s hard to give up on those positions when the market is falling.

Contrarians LOVE trading against the masses – because when the bus gets overloaded it tends to tip over.  My Real Money Pro colleague Doug Kass really loves trading against the crowd, and it’s no accident that he’s been in the game for so many years.

But the attraction to making money on the downside is intriguing to most because it is so rare, difficult and elusive.  When I managed pension funds at Sunkist back in the late 90’s, I had four very talented managers who were mandated strictly net short.   I used them to offset the volatility of the long managers I had in the fund, and it worked out beautifully.  Imagine how difficult that was when the markets rose in their face in what seemed like everyday.  Yet, they actually made money short in a bull market.

Why is trading the bear side so hard?  The long term bias for the stock market has always been up and while there have been short/sweet bearish moves over time the biggest money has always been made being long stocks.  However, not always the fastest.  We all have a mental block when it comes to being bearish.  Oh sure, we want to do it – but inaction usually follows that thought because we are going against the crowd, and who wants to lose if the rest of the crowd is winning?  I have found that being bearish requires being wrong for much longer than you are right, and can you handle that pain until you get paid off?  There are moments in time to be short and make money on the short side – when the Fed has a hawkish bias those tend to be the best times.

I started school at San Diego State in fall 1987, about six weeks before the big crash occurred.  The carnage and blood was everywhere following that Black Monday.  I was fascinated by the entire event, the fallout and eventual comeback of stocks – it intrigued me enough to pursue a career in managing funds in financial markets.  The stories of those who made millions from the quick down move were stunning, I wanted to learn and eventually prepare myself if something like this occurred again.

2013 seemed like an easy year to make money on the long side, right?  Buy the dips, make new highs, rinse and repeat.   Hindsight is 20/20, and coming into this year it made sense trading would be much more challenging.  How about making money to the downside?  Heck, the SPX and Dow Industrials are near all time highs and have only dipped at most 5% on the year.

For the first four months of this year, implied volatility has been averaging around 15% with only a few temporary spikes higher.  Where and when would you put on some bearish exposure?  Any push down was squashed quickly by the buyers.  Yet, some stocks have come down sharply.  High beta names like biotech and social media for example – which were riding high last year have been blasted.  Could you have been trading short these names?  Absolutely, but the signals were not so obvious.

I’ve been told by some, ‘Bob, you are good when the markets are going up – but I have yet to see you make money on the downside’.  For the past couple of years, this would be correct.   I’m a trend trader, and isn’t that what the trend has been?  We don’t have to be brain surgeons to figure that out.  As an options swing trader, a bearish bias would have mostly been a losing proposition.

While having some of these trades would have dampened overall volatility it would have brought down my overall results, which were strong over the last couple of years (up over 100% on risk in 2012 and in 2013).  I guess there is some fear that I can never trade the downside and that what goes up must go down.  Back in 2008 finding bearish trades was like shooting fish in a barrel, and we thrived.  Will we return to those days?

Not likely as the Fed is back in control of the game (unlike in 2007/08 as Jim Cramer told us!).  But I certainly believe there will be times to make money on the bearish side – this year and beyond – if you look for the opportunities within the charts, indicators and be bold and QUICK – you may just find yourself on the winning side of the trade.  Bob Lang