Most people who buy a stock think they’re making a bet on the company. You’re usually making a second bet.
The first bet is on the company. The second is on everything around it: the market, interest rates, the mood of other investors that month.
You can be completely right about the first and still lose money because of the second.
Picture the best house on a street in 2007. It had the best roof, the best kitchen and the biggest garden. Then the whole street fell 30%, and the best house fell with it. Being right about the house didn’t protect you from the street.
A long/short trade is a way to bet on the house without betting on the street. Or at the very least, of having some elements of a thesis offset to isolate those which are of interest.
A lot of investors are afraid of going short, but with a long / short, I know it can be done in a responsible manner. Especially with country ETFs where you’re using a full basket of stocks to express a view rather than two volatile single stocks.
To extend the metaphor from above, think of the world stock market as a city and each country as a street. When the whole city falls, nearly every street falls with it. You can own the best street in town and still lose money in a city-wide crash.'
A country long/short trade is a way to bet on one street against another. You buy one country’s fund, which is your long. At the same time, you short another country’s fund.
Whether global stocks rise over the next six months is a question which is hard to answer reliably. As I pointed out in my live session the other day, this market could very easily go both ways.
So you need to do your homework so that you can express a view.
Take an oil refiner and an airline, for example. The refiner sells fuel. The airline buys it. If fuel stays expensive, the refiner keeps more of every barrel and the airline gives more of every ticket away. In a recession, both shares can fall. The pair can still pay, because the airline falls further.
Country funds make this especially interesting. People talk about buying Canada or selling Mexico as if a country were one thing. A country fund is a bag of businesses with a flag on it. One might be a third banks. Another might be mostly factories and chipmakers.
Here’s the test I use before putting the trade on. I have to be able to say, in one sentence, what must be true for the long to beat the short.
For the refiner and the airline, the sentence is that: fuel stays expensive and the company selling it keeps more of the money than the company buying it.
And then you judge the pair as one position. If the long is up 10% and the short is up 14%, you don’t have a winner and a loser. You have a losing trade.
Today I reveal to you the 3 other Long / Short trades I put on yesterday, as well as more positions I’m initiating at market open. It’s a great time to be a stock picker.
