We’re told to be afraid of high beta stocks like Apple, having both a greater upside and downside. What if we seek to use this greater downside to our advantage instead?
High-beta stocks like Apple are normally viewed as a double-edged sword. They can make more money when times are good but can also lose more money when times aren’t so great.
The part that gets left out though is that we can lose more during so-called bad times if we stay long the stock during them. The first question we should ask here is, shouldn’t we not want to be in a stock when it is doing badly?
It is more important to ask this with a stock like Apple than it is with less volatile stocks, or the stock market in general if we are trading indexes. High beta stocks take bigger hits than your average stock, by their very nature, and they are also quite market sensitive.
During the selloff that we saw starting on October 3, 2018, the stock market ended up declining about 20% in the ensuing months. Apple, being more volatile and more sensitive to negative market sentiment, lost about 40%.
20% is the threshold of what we call a bear market, although this is an arbitrary measure, but twice that is definitely a bear, and this bear is twice the size of the one that invaded the party at the indexes.
Since Trump’s tweets early in May, the market has declined 7%, where Apple is now down 17%. Once again, the bears are just bigger and more powerful with Apple, and therefore do need to be more respected.
Apple is particularly sensitive to worries about China though, so we should not have been surprised to see this much bigger dip after Trump escalated the trade war with them. One of our first thoughts when we saw those tweets on that Sunday should have been to get ready to reverse our position with Apple, as this really did portend that the fun was going to be on the other side of the ball for a while, the short side.
There are ways to do these things with options, and some pretty sophisticated ones, but individual investors without a very good knowledge of options should really leave these things to the pros. Investors are intimidated by both options and shorting in general, and while they should probably remain intimidated by options, there’s no reason for this with shorting stocks.
A lot of individual investors who dabble in options, as well as people who want to be options traders, don’t have much of an idea of how challenging trading options can be. Unlike stocks, options are a zero-sum game, and being near the bottom on the skill and experience chart means that you will be particularly be subject to providing profits to the side that does know what they are doing.
Unless your options trading skills are at least above average among those who trade them, you will just ultimately lose money. We are up against people who do this for a living, and unless we are prepared to spend a lot of time learning and practicing, we are out of our league here and represent the dumb money, which should never be a goal of ours.
Practically every discussion about shorting stocks mentions that the risk with shorting is unlimited, versus with the long side where all you can do is lose all your money. If you are foolish enough to get to this point on the short side, you can count on your broker closing out your position for you. In both cases you are subject to being left with your pockets hanging out and a look of pain on your face, although there is never a reason to do anything remotely close to something this crazy.
Imagine shorting AAPL where it is right now and then seeing its stock price skyrocket, all the while wondering what to do. As long as you remember that you’re looking to make money from it going down, and not confusing your position with a long, or as long as you’re actually paying attention to your position and not just check it occasionally, the risk involved here is not substantially different than it is with buying the stock.
In fact, we’re more likely to manage the risk of a short better than we would with a long, because at least with shorts we haven’t been lulled into a state of comfort like we so often are with being long. We might barely bat an eye if our stock goes down 20% when we are long, but such a move against us when we’re short tends to scare us a lot more.
High Beta Stocks Like Apple Can Provide Nice Action in All Seasons
If we are willing to play both sides of a stock, it doesn’t get any better than high-beta stocks like Apple, where we can trade the concerns about its going down more than the market to our advantage. We now will make more money during bull markets, since it goes up more, and also make a lot of money during the pullbacks, where it pulls back more but our money is on that.
The goal here is to be paying attention all of the time and not just visit a stock like Apple occasionally and look to jump in during the middle of a move. This is what gets people in trouble the most, and the time to be in this current move down was back around the time the tariff escalation tweets were sent out.
Apple closed on the Friday previous to Sunday’s tweets at $211.75, and in the aftermath, closed Monday at $208.48, the time to get in on this. The following Monday, it was down to $185.72. Escalation week was a good one indeed for Apple on this side of things, but not so great for those who spent it long.
This was a special situation though, but we don’t need major news events to produce turnarounds, as this is more a matter of the market warming or cooling than anything else. We don’t just want to fire off a bunch of trades though without being confident enough that a reversal is likely, which would involve over-trading, and it’s not the fairly meaningless trading fees that make this a bad idea, it’s the slippage involved.
You can lose all of your money trading a stock that stays in a tight range, by buying it when it approaches the range, bounces off of the resistance, and then heads towards support. Your position goes south, you close it and reverse, but now the down move is over and it goes against you once again. You have to wait for a certain move to enter and if that’s as far as it goes, every trade will fail.
We want to be ready to leave a trade but we don’t really want to be too anxious. In this scenario, unless you are actually trading the range, it’s best to just stay put as long as where things are going once it gets out of the range seem to be in our favor. We certainly don’t want to reverse a position when it’s in a range though, and the better choice is usually to step aside for now and wait for the picture of what direction it is heading in to become clearer.
Thresholds for entries and exits when trading both long and short aren’t identical, and this is due to the need we have to manage risk. If we are long and it looks like the move is over, we can want to exit without necessarily being in a position to re-enter on the short side.
It could just be that the future doesn’t look clear enough for our side and we want to be out, which is actually pretty wise, but it doesn’t look all that clear for the stock to be going down either. Less experienced or skilled traders often will want to be in the game all the time, or too often, where better traders realize that there are three states here, which are long, short, and flat, and our task is to decide which is the better option right now.
Migrating Toward the Dark Side
There is no fine line between trading and investing, and those who would categorize themselves as investors may be up for something else other than just hanging on to your stocks and hoping that the markets are kind to you as they are supposed to be.
There is a learning process here, and we’re not going to want to have all of our money on the line here or anything close to it as we get comfortable with timing positions as well as betting on stocks going down. Once we do get more comfortable, we will want to add to the amount of money we are using for this, but we always want make sure that we are staying within our limitations and make caution the top priority.
Going from an investor to a trader of sorts, one that would have been looking to profit from the pullback in the fourth quarter of 2018, the rally since, and this recent fall shouldn’t really involve placing more than a few trades a year, and this is an example of three that what a position trader may make.
We need to avoid the temptation of trading every time we hear a bell, unless that’s what we’re looking to do, and a lot of bells go off during a stock’s ride up or down during a larger trend. The signal and noise analogy is often used, and we need to seek the signal and not be distracted by the noise, which means that signals are more major in appearance and outlook.
If the bear market that we’ve been talking about does come, or if it is already underway, being open and willing to short can take us from something we fear and something that will cost us a lot of money to a real opportunity that can make us money instead of losing it.
It is actually easier to make money on something going down than it is from it going up, because moves down tend to be both more dramatic and more transparent, which means more return on our money overall. We do need to banish all of the false ideas and biases we have and realize that the goal of investing is simply to make money, and shorting is one of the two major ways we can do this.
Apple is a particularly good stock to short with its massive float and liquidity, and if others are comfortable enough losing money with it and hope that it comes back soon, we can grab some of this money that is flying out of windows if we are up for it.