Unlike most of the writers and readers of this magazine, who focus on investing, traders think differently. When stocks fall, investors panic. Traders see opportunity. When everyone is panicking, we welcome the volatility. A friend who runs his own hedge fund has had his best week in years, and he mentioned to me the moral dilemma – profiting from times of distress and despair. He is a currency trader, and so in a pair there is always a long and a short.
There is a lot of controversy around shorting. Shorting is open to abuse, sadly – I have my suspicions about how certain individuals misuse it to manipulate stock prices down for their own gain. But how sensible would it be, and how efficient price discovery, if people were only allowed to take a one-way position? Few complain when stocks are gathering upward momentum, blowing bubbles, or when investors who pile in at the top lose their shirt when the bubble collapses. Clearly, that is also blatant value destruction. In my view, the answer is not to ban shorting, as we have seen happen on certain Spanish and Italian stocks on the London Stock Exchange this week, but better regulation, such as suspending a stock when it is raising fresh capital in the form of a placing. Delaying selling pressure only means more explosive downward moves in future, as there are no bears to temper rampant bullish sentiment.
It would be extremely difficult to make money being net long in this market over the past few weeks, when the overwhelming trend has been down. We have seen unprecedented price movement also due to the collapse in oil, with Royal Dutch Shell (RDSB) diving 12 per cent in a single day as the FTSE saw a rout not seen since 1987. This is uncharted territory, and traders must be alert and ready for action. Cineworld (CINE) is a case in point: since the beginning of March, Cineworld has fallen from 156p to below 20p. But while it’s heavily shorted and has offered many opportunities to scalp long in the intraday period, that also means it has been prone to short and sharp rallies when shorters can be squeezed. Also, remember that if a company goes bust and its shares cease trading, while a shorter is paid out in full this can take months and many brokers even make the position 100 per cent margin, thus rendering holding a short position to 0p unattractive.
Last week we looked at Greggs (GRG), which promptly sliced through the short entry level I identified like a hot knife through butter. And while it’s nice to call a trade correctly, if I had been wrong (which I often am) my losses would’ve been ruthlessly cut. In periods of extreme volatility, it’s important to not let oneself become too offside on a trade. Only by doing this can we protect both our physical capital, and just as importantly our psychological capital. A punch-drunk trader cannot trade effectively. This is not a time to be scared to get stuck in. I will continue to short so long as the trend is down; however, I do believe that when a bounce inevitably comes, there are various oversold quality stocks that will offer rip-roaring long trades. Short traders need to be on their guard for this moment.
Unfortunately, nobody knows when that bounce will be. I have had to rewrite this article completely, because share prices have moved so ferociously that by the time it goes to print it would have been old news – such is the speed of the collapse. Not even 20 sessions ago, global equities had not factored in any effects from coronavirus at all. I take that as an encouraging reminder that the financial experts are not always right and that there is always opportunity for traders.
Looking at Chart 1, we can see that the FTSE flirted with the 5000 level and dipped below. It’s a level we haven’t seen since 2011. It’s also a big round number, and many will be watching to see if this level holds. The UK government has just launched a huge stimulus package, but it might not be enough, such is the scale of the damage inflicted by Covid-19. Sadly, there seems little that can be done to stop many leisure and travel businesses going under, and a decline in transactions inevitably has a knock-on effect on future transactions. The problem is already entrenched.
If we look back to 2008, that crisis wasn’t over in a matter of weeks; it was a long and protracted downtrend, and for active traders it provided plenty of volatility. The real economic impact of the current crisis means we face a similar-length period of uncertain markets – bad news for the economy and investors but fertile ground for traders.
One FTSE 100 stock that I think is going to offer plenty of action is Marks and Spencer (MKS). I highlighted this as a short in our Companies & Markets podcast ‘Slinging Mud’ – the net debt that is covered by prime retail property on the balance sheet is not looking very healthy at all now.
In Chart 2, we can see how the stock has fallen through the 2008 support line (top red line), only to bounce off the all-time low (bottom red line) and rally. However, the stock is now through all levels of support and has been in freefall. Since the start of the year, short interest in the stock has been rising. The business has razor-thin profit margins, with every downtick in revenue hurting the bottom line. The coronavirus crisis is going to harm the business more than other retailers because a lot of its clientele tend to be of an elderly disposition – the very people who have been urged to stay indoors and self-isolate. Combined with high debt, including lease liabilities, and the falling value of its owned retail assets, that could be catastrophic.
I believe we are going to see decimation on the high street; many self-employed and small businesses do not have the cash buffer to withstand the coming onslaught, and consumer spending is likely to be slashed as confidence ebbs and people stay indoors. It will be a storm not seen since 2008, if ever. Nobody is questioning whether we are now entering recession territory. The only question is how bad will it get? For M&S, 0p is starting to look more likely.
Meanwhile, the trading battleground is changing on a daily basis. It’s impossible to call swing trades here, because governments are responding with measures constantly, and stocks are moving with extreme volatility. Traders need to decrease position sizing (covered in 'Size matters', IC, 1 August 2019) to adjust for volatility and run tighter stops. Such volatility and trends are going to offer the potential for higher payouts, which means we now need to be risk on and trigger happy.
Intraday trading is the order of the day now, as overnight risk is too high. For example, I closed many of my leisure and travel shorts knowing that the government was expected to help these businesses in a speech outside of market hours. We need to be aware of key global and UK announcements because what is said in these speeches will move stock prices.
Some key points to remember:
- The trading landscape has now changed and therefore strategies must also change.
- Identify gap-ups that are running out of steam and fade the rallies.
- Reversion to the mean scalps as the trend overshoots in both directions.
- Consider shorting stocks that have not yet warned but are likely to warn.
You can contact Michael and download his free trading handbook from www.shiftingshares.com
Twitter: @shiftingshares
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