Market volatility and the continuing sideways movement of the All Ordinaries has made the buy-and hold investing strategy that was so prevalent until the recent financial crisis much less attractive. In its place, investors are starting to more regularly re-evaluate their portfolios. Shorting stocks is also gaining popularity.
“Investing for the long term is always the most popular strategy but we are seeing more and more people interested in day trading. The reason is because everyone is becoming keenly aware of the risks of increased uncertainty and heightened volatility in the markets and they want to have better control of their positions,” says Kathy Lien, director, global research and analysis, GFT.
“Investors who used to hold positions for months at a time are re-evaluating their exposure week-to-week. Shorter-term traders have become even more short-term focused, looking to hold onto their positions for only a few days if not hours,” says Lien.
But day trading is not for the feint hearted. “Overnight news flow ends up killing a lot of traders. When Australians go to sleep, Europe and the US are in full swing and big rumours or announcements are made, sending shares and currencies into a whirlwind when trading opens. This type of dynamic makes it very important for people to use stops,” says Lien. A stop is an order to buy or sell a stock when it reaches a pre-determined price.
Anthony Skotnicki who is the head of JBWere’s markets desk says although there is less appetite among traders for buy-and-hold strategies, investors do still take positions with a long term view. “But there is a need to constantly review why you have bought a stock and we are increasingly seeing more activity around portfolios.”
Skotnicki says shorting stocks is becoming more popular with investors, although he says it’s usually more sophisticated investors who use this approach.
“People are tending to short stocks if they have an outright negative view around the long-term structural challenges facing a sector or stock. They also short to neutralise the volatility of a portfolio – although we tend to use options to achieve the same effect. The other reason people short is when they are pairs trading,” he says.
Pairs trading is when an investor goes long in one stock and shorts another, usually in the same industry sector, for example if they believe the stock in which they have taken a long position has the potential to take market share from the stock that has been shorted.
Chris Weston, head of institutional dealing with IG Markets, says investor interest in short selling has increased dramatically over the past six months.
Weston says “given the fears around Europe, there has been a huge pick up in shorting every asset class.”
“There has always been scepticism in Australia around shorting because people didn’t understand how to short something they don’t own. A minority also didn’t want to profit from a company’s misery. But now people understand how to borrow a stock and sell it back. As markets have traded sideways people have become more sophisticated in how they invest. People are viewing the world with fresh eyes,” he says.
Investors must be aware of the risks of shorting. “The biggest one is the unlimited loss scenario if the stock goes up and you have to buy it back at a price higher than you expected – there are no limits as to where the price could go,” says Skotnicki.
Lien says it can be difficult to avoid being ‘caught short’ when shorting a stock. “The only tip I have for anyone unsure of their position is to reduce exposure,” she says.
Having the right information is critical to short effectively. Investors need to stay on top of economic or earnings releases that could threaten trades in the short-term, as well as the liquidity the instrument has.
“Less liquidity and trading activity could make the stock more vulnerable to a short squeeze,” advises Lien.
The most market moving economic releases tend to be the jobs figures, GDP and inflation reports, along with the central bank rate announcements. For Asia, Chinese economic data is also critical to watch because it can set the tone for the general market.
Originally appeared in the Australian Financial Review 20 March 2012