Short Selling

There are so many different ways to make money in the stock market. The most basic way with stock shares is to buy them low enough and then sell them at a higher price later.

Did you know that it’s possible to make money in the reverse? You can sell shares in the market at a higher price first and then buy them back at a lower price later. This is called short selling.

The concept of short selling had me confused at first. I’d only heard that it was something a lot of traders did when they anticipated a drop in stock prices. None of it made sense until I executed my first short sale.


My First Short 

Many years ago, a certain company messed up royally and was getting a lot of bad press. Shareholders were selling in a panic and the share price was dropping in high volumes. I saw that the price was at around $76 and I believed it would go down more. I lined up my order to sell 600 shares at the current market price and I hit, “Short.”

After that, the price fell considerably. In the order box I clicked on, “Cover,” and I bought back 600 shares at the new market price of $74.75. That is a share price difference of $1.25. With 600 shares, I made $750, excluding commissions.

Broken down, it looks like this:

  • I short sell 600 shares for $76 per share (600 x $76 = $45,600). By doing that, I’m borrowing the shares from my brokerage to sell in the market for that price;
  • The share price falls;
  • Then I buy back (or cover) 600 shares at the current price of $74.75 (600 x 74.75 = $44,850)
  • At the end of my trade, those borrowed shares are returned to my broker. I get to keep the difference in the short sale for a profit of $750;
  • $45,600 – $44,850 = $750.

Despite the order at which the transactions occurred, the concept of buying low (at $74.75) and selling higher (at $76) is still preserved.


The Downside of Short Selling

As great as it sounds to make money when share prices are heading down, short selling is a riskier practice. Here are some reasons to consider:

1.Many investors don’t short sell or even know what that is. This means you don’t always have the majority of the market on your side.

2. Shorting is made possible when your brokerage firm has the shares to loan you from its own inventory of stocks. These stocks are either from the firm’s own positions or from the positions of the firm’s clients. If your broker doesn’t have the shares to loan you, you cannot short sell the stock. You end up missing out.

3. The market is generally optimistic. This means the fear and panic don’t always last as long as you might hope to support your short sell. Price reversals can happen fast. You generally need to have a shorter time horizon for shorts and you need to be watching your positions more closely.

4. When you buy a stock in the standard fashion, the worst thing that can happen is that your share price drops to zero before you’re able to sell it. In this scenario, the most you can lose is the entire amount of your investment. When you short a stock, the share price can go up indefinitely — this means you can lose more than the entire amount of your original position. Potential unlimited losses is what makes shorting considered a high-risk practice.

5. Profits from short selling are normally taxed as income rather than as capital gains. This is not favourable taxation.

6. If the company that you’re short selling is paying out a dividend, you have to pay the dividends owing to your firm or to the client those shares are being borrowed from.


Why I Don’t Short Sell

The reasons above are enough to discourage me from shorting, though there are many more that I haven’t mentioned. Short selling is a more advanced way to make money in the stock market and is best left to the pros. I don’t short stocks anymore because I prefer to own them.

I normally don’t discuss short selling because it’s not for most people, not to mention it’s really confusing. I only feel like it’s relevant to discuss shorting in a market like the current one so that new investors can understand the additional reasons why the prices of their stocks might be going down so much. It’s not just from investors collecting profits or abandoning their stocks out of fear of losing more — it’s also from short sellers trying to profit.

After the short sellers have had their fun and after all the panic selling and pessimism have subsided, it usually takes a while for a stock to recover before going up again with more investor confidence. I’ve got my wish list of stocks to consider buying when all the selling is over, so I’m just waiting for good setups and a better market.


Alternatives to Short Selling

Even when the whole market is negative, I don’t always want to sell my stocks, nor do I short any stocks, as you already know. Sometimes to combat the downward funk, I will buy shares of inverse ETFs to make money in the interim.

Inverse ETFs are exchange-traded funds made up of more complex financial instruments that generate money when the market is moving down. Like a regular ETF, its movements mimic the market index ETF it is modelled after, however, it’s designed to go in the opposite direction. Basically, when the market index goes down, the inverse ETF goes up. 

Index ETFs are often created in a way to move up to 3 times more than the index performance or up to 3 times less. These differences in performance can either enhance your trade or really hurt it when you’re wrong.  You have to be careful and consider this when selecting ETFs.

I still regard buying an inverse ETF a very risky strategy as it’s still in theory ‘shorting’ the market. Also, inverse ETFs tend to have higher management fees because they consist of higher maintenance assets than most regular ETFs. Higher fees and MERs in funds diminish their value and overall returns. For this reason, I usually only buy and sell them for shorter-term swing trades.


Before investing in an inverse ETF or deciding to short sell anything, please consider the risks. At this point in time (it’s December 2018), I think the market will go up a bit more before it goes down again early in the new year. We’re so close to the year’s lowest trading levels of the US markets. I don’t think things will really start moving up again until we at least break below those 2018 levels first.

I know a lot of investors who have been feeling beat up and want to do something to save their portfolios. If you’ve been feeling this way for the last few months, the best thing to do at this point is to think of your future strategies for your portfolio and be ready for them once the market is more positive.

Remember that downswings and bear markets are a normal part of the cycle for stocks – nothing goes only in one direction forever. Going short now after the market has gone down so much is not only is riskier, the returns won’t be as great had you gone short in early fall.

Money Talks

 

Recently, I did a presentation at the Toronto Public Library on investment basics. I had no idea how it would turn out, but I ran through my head a number of best and worst-case scenarios. It was better than I could’ve ever imagined.

I’d never seen a more diverse audience in age, background, and investment interests. Each person was comfortable enough to engage or ask questions – great questions, I might add. To all those who attended, I’d like to offer my deepest gratitude for your participation. This was the conversation I’ve been dying to have with people. This is the type of conversation more Canadians need to have with each other.

Today I’m going to share with you the questions that I can remember. I’ll add parts of my original answers, but I want to answer the questions more fully. These are in no particular order.


How long does it take for you to do your investment research each week?

Now, it’s a few hours a week, anywhere from two to six hours. But I also apply up to 20,000 hours of previous learning and experience. I hope that I can help others enough so that you don’t have to take as long as I did to learn how to invest.

I’d like to also add that many of my decisions result from bouncing ideas off my man, JP. He has put in the time and discipline to learn as well. We have the advantage of combined knowledge and experience. I share a lot of these very ideas in my weekly blog.

As much as I’d like to spend more time doing research and trading more actively, I would become more prone to micro-managing my trades. I’ve done a lot better with a more passive and hands-off approach.

How did you get a 70% return last year?

2015 was a terrible year for the Canadian market. The loonie and the Canadian economy were weak. We patiently waited for the market to stop going down. This happened around late February 2016. We looked for stocks that we knew traded actively and had suffered huge drops in share price. It was a very good time to get into the market. These opportunities don’t come very often.

We bought shares in TECK.B.TO, ECA.TO, BBD.B.TO when they were really cheap, and then in April, bought some APH.V (now APH.TO). We bought a few other stocks, but these few alone did very well after just a few months. We kept selling shares incrementally each time the stocks surged in order to secure profits (called ‘selling into the strength’), but they kept going up. We could’ve done much better had we just kept the shares in and moved up our stops (selling prices). It became a decision between banking on certain profits and waiting to see what will happen. We did a bit of both and we still have shares in all those stocks.

I don’t anticipate as big a return this year, unless the market has a major correction, soon after which there’ll be many more big buying opportunities (a bad and selfish thing to wish and wait for, I know, but…). My US portfolio, though, has been my big winner this year because I had the same idea with US tech stocks last summer.

One of the things I always say is that investors are always looking for new opportunities.

What ETF should I buy?

Many financial institutions create ETFs. Some are:

  • BMO
  • Horizons
  • Vanguard
  • iShares
  • Claymore

When doing your research, consider your investment objective – dividend income, market index performance, sector selection (like banking), fixed income, etc. Also consider the MER, share price, distributions, and frequency of distribution payments, to name a few things. You can look up this information on the ETF info sheet. For me, I only select among ETFs with higher trade volume.

Market ETFs can swing a lot in price because of the demand of traders in the market. So the ETF might be worth more (or less) than its actual value (NAV). Would it make sense to put some money in a market index ETF and some in an index mutual fund (which will be less prone to price swings)?

If you want to invest in the market, consider an ETF or an index fund – or both. The major distinction between these is the MER as it’s a lot higher for mutual funds than it is for ETFs; however, it can be more affordable to buy units in an index fund than it would be to buy shares in an ETF.

An actively traded market ETF can experience more volatility than the actual index it’s based on. Its price will vary based on the demands of buyers in the market. If buyers drive the price up, it’s possible for the ETF to be worth more than the net asset value (NAV) of its assets, so you’re paying a premium in share price. If investors are fearful, heavy selling can drive its price down below its NAV, so it’ll be trading at a discount. For index funds, the NAV is what it is after the market closes. At the end of the day, you shouldn’t notice a big difference between similar index funds, be it an ETF or a mutual fund. (If you do, the mutual fund will likely be underperforming because of the MER.)

What’s most important is that you’re 1) comfortable in what you’re investing in, and 2) you’re not paying too much in fees.

What do you think of mortgage-backed securities?

These have had a bad reputation as these were hugely responsible for the 2008 recession, but mainly because they were deregulated. They’re just bundles of mortgage loans that pay investors interest.

If you’re after real estate income, the REIT (real estate income trust) is great because it can pay investors their share of the distributions which will come from a mix of rent, mortgage interest, capital gains, as well as return of capital. You can also get real estate ETFs. Because of the mixed forms of investment income that come from these, they’re best held in registered accounts. Also, keep in mind the MER. I own a couple of these to add diversification to my portfolio. Other than the value of real estate happening in my own backyard, I don’t really follow the real estate market as much as I should.

What brokerages do you use?

I have opened accounts in the past with Disnat Direct and Questrade. I now have accounts with Virtual Brokers and Interactive Brokers. I’ve been with the last two for years.

What do you pay in commissions per trade?

With Virtual Brokers, I pay 1 penny per share. It’s less if the stock price is under $1. With Interactive Brokers, it’s 1 penny per share, but a minimum of $1 per trade. So if I buy 125 shares, I pay $1.25 plus any market data fees.

Both of these accounts were opened as margin accounts – trading on margin means you need to open with and maintain a minimum amount of cash in the account which allows you  3 times the buying power. So if you open with $25,000, your buying power is $75,000. To attract active traders, the commission fees are very low.

I also have TFSA and RRSP accounts with Virtual Brokers (VB). Thanks to JP’s slick skills in negotiation, we managed to have the same awesome rates extend from the margin account to our registered accounts. Often with registered accounts, you get charged a quarterly administrative fee. With VB, they do charge $25 plus HST unless your account has a minimum of $5000 in it.

I am an active FOREX trader. How should I be doing my taxes every year?

With an accountant. I did our taxes the first couple of years we started day trading. I had the advice of a friend who’s an accountant. She gave me samples on how to calculate the adjusted cost base of securities and their exchange rates, etc. It was actually a really good exercise in learning about taxation for the self-employed and how to factor in fees and expenses; on the other hand, it was a total headache. After that, we started using an accountant who magically does it all in a few days.

What is your take on robo-advisors?

They’re great if you don’t know what stocks or ETFs to buy, or when to sell them. They take away from you the inconvenience of guessing and researching and they make those decisions for you. I’d just be cautious about the frequency that the portfolio is rebalanced and focus on the ones that meet your criteria and charge the lowest fees. As you get more comfortable and savvy with reading the market, you should compare how your portfolio is performing against it and decide then if you might be better off investing in an ETF.

What is your advice for women and their investment choices, especially as they age?

Women have developed a reputation for being great long-term investors because we typically make conservative, less risky decisions. I feel that the financial markets have shifted so that being conservative could work against us in the long-term. Those traditionally conservative decisions, like owning a lot of GICs and low-risk mutual funds, could leave us with less money than what we actually need to have, especially as we live longer and longer. We should be thinking about how our portfolios need to keep generating income as we age. In my opinion, we should consider dedicating more of our portfolio to more medium-risk choices, like blue chip funds or stocks that pay us a dividend.

I know I have a pretty aggressive approach when it comes to making money, but I’m careful with most of my money and more risky with a smaller amount of it (or maybe that’s just what I tell myself and it’s more like half and half). A big part of my own early retirement plan is to live off of dividends, although I still want to make money on capital gains if I have to sell my shares to rebalance my portfolio.

What are good websites that could tell me more about Canadian securities?

I drew a blank – thank you to the audience members for their helpful input. Motley Fool Canada and Retire Happy were mentioned. I also think that Canadian Couch Potato and My Own Advisor are excellent.

You must have a really diverse portfolio?

Yes. It not only keeps things interesting, it spreads and reduces the risk factors within my portfolio. A lot of my trade decisions come from looking at the sector or industry first. That’s why the economy is a big part of my book. I have stocks and ETFs across many different sectors.

I risk very little for each stock, so I’m not worried if it turns out to be a dud (a rare occurrence). After a while, if I like a stock enough, I’ll buy more shares if there’s a new entry (called scaling in).

How do you research fundamentals?

I said I cared about two things: the price I got in at and dividends. I’ll admit, it was a shortcut answer. I don’t pay as much attention as I should to the fundamentals mainly because I learned about stocks from traders who studied price charts and used only technical analysis. When it comes down to it, even if a company’s fundamentals look good, if the stock price has gone too far up or isn’t trading well, I just won’t enter.

I use technical analysis for all my decisions and I apply very general guidelines when considering a company’s fundamentals. One day, I’d like to take the time to figure out how to use both forms of analysis to become an even better trader. For now, I rely on good charts that indicate signs that a trend is about to start; I look at the sector the stock is in; and I compare the stock to other stocks in its sector. Then I cross my fingers hoping that the rest of the market catches on and buys the stock up.


We all have different ideas on what we want to do with our money. There are so many different ways to apply strategies, even between people who have similar takes on risk and opportunity. What I think we all need to have is a general basis of knowledge and from there, we each can branch out and find our own approach to investing.

Thank you, TPL! I had a wonderful evening.

 

 

Earnings Seasons for Stocks

There are a few things that can rock the stock market positively or negatively: a major world event, a major company gets caught up in a scandal, election results, or company earnings.

Four times a year, publicly traded companies announce their quarterly earnings results. Some companies (like Apple) are such sector and market giants that their earnings will affect the whole sector – and sometimes entire market.

Earnings season definitely adds an element of uncertainty. If a stock you’re interested in buying is scheduled to report its earnings, buying it beforehand could work for or against you in a big way. Suddenly it feels like you’re placing a bet instead of making an investment.

It’s great if it gaps up in price. Your portfolio will glow thanks to this stock’s incredible move. You’re an amazing investor and have become unstoppable at picking stocks. It’s in your destiny to be the sage investment advisor among your peers.

If the stock gaps down, the feeling is the complete opposite. You’ll be spending your time looking into why the company had good earnings, yet it still came down hard in price. What horrible luck were you just cursed with?

Financial analysts are always trying to predict the earnings results of major companies. What happens then is that traders start to take their positions and buy shares in anticipation of the price going up in a big way. When the actual earnings report comes out, if the predictions were correct, the price usually goes up by a lot because other investors who were waiting on the sidelines are now acting on the correct information. If the predictions are off by a lot, it can send the share price down – even if the company had a better quarterly earnings report than the analysts predicted.

This doesn’t seem to make sense until you start thinking about the psychology behind pricing. There is one thing you should never lose sight of: Stocks move in price based on investors’ perceptions. Analyst predictions are important because they shape people’s perceptions on what they think is a fair price for shares. So, even if the earnings are predicted to be weak earnings, investors can decide on what is a fair share price based on those predictions. People like predictability, even if the information isn’t always good. We don’t like unpredictability because it increases uncertainty. The root of risk lies in uncertainty. 

If you’re planning on buying a stock that has yet to report its quarterly earnings, you can either wait until after its earnings report comes out, or just buy a fewer number of shares to lower your exposure to risk. Sometimes, after an earnings report, the share price stays the same. If it’s higher or lower in price by a significant amount, then I recommend waiting until it settles down before buying more shares. Any big move will trigger a lot of action before it gets quiet again. The trading volume will eventually go down and the daily price ranges will go back to being average. Refer to any of my lessons on price consolidations under the category, “How I Find and Pick Stocks.”

If you own a stock for a while, you’ll know that the big ups and downs from earnings come and go like the seasons of the year – it does happen four times a year, after all! You need to recognize that you buy a stock for more than just its quarterly reports. You invested in the company because you like its product or service, its sector, its dividend, and hopefully, the low price you got it at (thanks to all the techniques I’ve been trying to teach you!).

Stock Video!

Watch the Loonie to Toonie Stock Video!

Finally! My stock video is ready for the world – specifically the world of people interested in reading stock charts, which I believe is a small, yet growing world. My hope is that one day, reading charts of investments is no longer a practice unique to investment pros, but a basic skill that we all have.

You can hit it big in stocks without ever having to read a chart, but for me, it’s key to my decision process. I created this video to provide a more visual supplement to all the information that I’ve been sharing on how I find and select stocks. 

I’m often asked where to find stocks. I feel it’s important to not only tell you where I find stocks but how I decide on which ones to pay attention to. I hope this helps you in your investment endeavours! 

New to Investing? Everyone Was at Some Point

Everyone who invests had to start somewhere.

Folks who have invested for much longer than a new investor started at a time when investing looked a lot more different. I’ll tell you about my investment journey that began over 20 years ago. I’ll also give some tips intended to give you things to think about as you read on.

The ’90s vs. Now: GICs and Term Deposits

20+ years ago, I opened an RRSP and my first investments were term deposits and GICs. These did all right as I was only interested in saving part of my pay cheques and not spending the money. This was at a time when interest rates were better. They were paying me 4.5% to 5%. It made sense for me to start out this way.

Now, putting your money in these is mainly just to lock it up. Interest rates are very low and these only offer a better rate with longer investment terms. It’s safe from you when you have spending urges, but not safe from inflation. If the inflation rate is 1.13% and your investment is paying you at 1.20%, then you’re not getting much of a return. If inflation rises to 1.5% during the term of your investment, you’ll find out the meaning of “inflation risk” the hard way!


If you’re new and nervous about investing and like the guaranteed aspect of GICs, you could get a variable rate GIC if current interest rates are low. You could also get an escalating rate GIC, particularly if you wanted to keep the money invested for a while, like up to five years. If you’ve always wanted to get into the stock market but was nervous, you could get a market-linked GIC. If the market goes up, you can make more money too (although there’s usually up to a maximum amount that you can get). If the market goes down, you get your principal back and you don’t lose any money, just time.

Because the returns aren’t that great with these cash investments, investing in an RRSP at least allows you to claim your contribution and get back more on your tax return.


The Early 2000s vs. Me: Mutual Funds

As my savings grew, I moved onto mutual funds. I had:

  • a Canadian bond fund
  • a Canadian index fund
  • a monthly income fund
  • a Canadian blue chip equity fund
  • a balanced growth fund
  • and a dividend growth fund.

These did all right, but I felt my portfolio should be doing better. I was regularly putting money into my RRSP – these additions seemed to mask the actual mediocre performance of my mutual funds. Little did I realize it was the high MER fees that were negatively affecting my returns.

When I asked an advisor about rebalancing the funds so that they could perform better, he told me I shouldn’t because he’s seen people doing much worse than my portfolio. Wow! That didn’t help me or encourage me. He just said he wouldn’t change anything – besides, I’d lose money from all the load fees I’d have to pay if I did move things around.

I was so frustrated because my online account made ‘switching mutual funds’ look commission-free and as easy as clicking a button. I didn’t know the difference between one fund from another. That’s why I went to the bank to ask for help. Advisors are supposed to be more helpful and if not, at least informative, right? So, I went to another branch and saw another advisor who was even more useless and uninterested in my concerns. It was so different from my experience when I had a big chunk of savings that I didn’t know what to do with. I had received such great service then. After I made the investments, it seemed no one wanted to assist me. 

I was much more angry with myself because I didn’t even know how to have the conversation that I wanted to have when I met with these advisors. I lacked the knowledge and vocabulary to know how to drive the conversation to get what I really wanted. I couldn’t tell you what a bond was. I didn’t know what “equity” meant. Is it an advisor’s job to teach me? Or was it more advantageous for them if I knew nothing? I don’t mean to rag on mutual funds and advisors. It really was just a situation that I outgrew and became frustrated with. Sometimes growth just ain’t pretty.


I actually think mutual funds are great for new investors who don’t have much in savings yetIt’s great to be able to buy shares or units in a fund and co-own assets (wait–does that explain the essence of the term “mutual”?) that you wouldn’t be able to afford otherwise. As you grow your money, you’ll be able to afford to buy the actual assets directly. Until then, take advantage of automatic deposit options to enjoy the compounding effects of regular investing.

Mutual funds are so easy to get at your bank. The advisors can help you find the right balance of funds based on your risk tolerance. Just be sure to ask about the fees! Only opt to pay lower fees, but preferably go with the no-load fee options. If you’re deciding between two similar funds, choose the one with lower MER fees. I think mutual funds are best in the RRSP, not just because of the bigger tax return you could get for claiming contributions, but also because if some of your funds have US stocks, the dividends aren’t taxed in your RRSP.


The Late 2000s to Now: In Love with Stocks

I was frustrated enough to cash out my mutual funds and say sayonara to my bank. I parked my money in a discount brokerage and took the free stock trading program that came with opening an account. I took business and financial courses, including the Canadian Securities Course, to become more educated about money. I badly wanted to know what the financial industry knew and how the world of money worked.

The more I learned the more stoked I got about investing, particularly in stocks. While I’m still working on where I want to be financially, I now see my long-term financial goals happening a lot sooner thanks to stocks. And I’m still educating myself and trying to learn.


If you’re new or too busy to know what stocks to buy, get an index ETF for the Canadian and US markets. If you want a bit of diversification, get a sector or international ETF. If you want income, get a fixed-income or dividend ETF.

If you’re new but ready for more than just ETF investing, you can pick blue chip stocks that pay a nice dividend. As your financial knowledge increases, you can build a nice diverse portfolio with a suitable balance of cyclical and non-cyclical stocks.

If you have a US ETF or stock, invest it in an RRSP so the dividends aren’t subject to withholding tax. If your financial goal is more short-term and you’ll want the money in a few years, invest in the TFSA so you can withdraw the money without getting taxed. You can invest your money between both the RRSP and TFSA according to your different goals and needs. If you run out of contribution room, then hold your Canadian equities in a non-registered account to benefit from the favourable taxation on capital gains and dividends.


The 2010s: Educating Others

Once people knew that I was really getting into the markets, the inquiries starting pouring in. I didn’t feel that what I knew was applicable to my friends’ various situations, though. As much as I believe everyone should own even just some stocks, stocks aren’t ideal or applicable to everyone and for every situation.

I began to ask at my bank (not the one I ditched) questions on behalf of my friends. The advisors were so friendly and receptive. Sometimes they’d sit down with me if they felt the questions were more involved. Other times, we’d all be just talking about investment options. I was always impressed with what they knew, how willing they were to answer questions – even if I wasn’t going to invest my own money – and how much more focused they were on the client relationship aspect.

I’m not sure if the great random service I was getting at any given branch was the bank itself, if it was because I knew what I was talking about which led to better, more informed conversations, or simply because financial advisors now are supposed to be more focused on building relationships with clients for their VARIOUS needs, rather than just selling them investment products.

I actually wrote my book for my friends. I wanted the information to be easy enough to access and understand so that even if they had a general concept of how investments worked, they could seek and get incredible assistance from the pros. My book is meant to help liaise between the client and the financial industry and ultimately help investors navigate their available options.

I still get questions from my friends, mainly the ones who haven’t read my book yet! That’s okay. As my confidence over my own investments grows, so does their willingness to learn from me about how their money can make them money.