Being Skeptical of Skepticism: The Best Kept Secret of Short Selling

Introduction

This holiday weekend has given me the opportunity to be reflective/introspective of the last 10 years of my life. As a result, I feel the itch to write about a few specific topics that have been on my mind for the last 1-2 years.

I suspect this post will be most relevant to and best understood by those who possess the genetically defective “short seller gene”; probably applicable to bona fide contrarians as well. If a wider audiences finds this post useful, entertaining, etc. - all the more better.

The Best Kept Secret of Short Selling

I will get straight to the point: I believe the best kept secret of short selling is… to become skeptical of one’s (and others’) skepticism. It is to be doubtful of doubts. It is to harness this preternatural gift of short selling that is ordinarily used by the short seller to identify fraud/fads/failures (while others see nothing), and instead, use this gift to identify cases where one’s or others’ suspicions of fraud/fad/failure are misplaced… and climb walls of misplaced worry. The best kept secret of short selling is to go long, with a long-term orientation.

One of the most useful talents that short sellers tend to naturally exhibit: what might make for a bad, maybe terrible long investment. Short sellers, in theory, can do a far superior job versus the long only investor, of filtering out what NOT to invest in, waste time in (e.g. value traps).

I will posit that not only is this the best kept secret of short selling, it is actually critical + necessary for survival, for most people… otherwise, one risks experiencing crippling financial losses, career instability,  household turmoil, mental illness, and even, suicide.

Becoming comfortable with consensus and trend following

I have naturally contrarian tendencies (oddly enough, I avoid using the word ‘contrarian’ as I find many pretend contrarians who use the word dozens of times a day), but have found that the status quo is actually often correct: it pays to be with the consensus most of the time.

Without me knowing it, I started testing this ‘best kept secret’ in 2011… though meekly. While I have slowly become emboldened over time, I remain somewhat meek. My primary mistake has been selling longs prematurely: I probably felt that if the market was showing some validation of my position, I must sell. Yet the biggest money to be made would’ve been to hold on to longs, even as they became consensus positions - even ‘crowded’ positions - over the course of several years. I should have continued being skeptical of my own skepticism.

My best friend has jokingly said that if I sell a long position, it will double over the next 2 years. I bet that if I can learn the ability not only to hold onto a position as it becomes accepted by the mainstream - but to size up the position as it works in my favor - I’m inclined to believe that good things will be happening to me.

 

Complicating Factors and Important Context

• Some might assert that the existence of this post itself would imply we are at a peak in risk asset prices, or in late stages.  I keep an open mind to that possibility…yet, these thoughts have been on my mind and put into practice for several years now.
• My above thesis might sound fine and dandy in theory, but in practice, I’ve found that some people are just naturally inclined to buying stocks, while others are just inclined to shorting stocks (though the latter is a tiny minority). Habits/character are difficult (maybe impossible) to change.
• I’ve seen some short sellers (and former short sellers) whose long books seem to be exclusively dedicated to short term short squeezes. They don’t have a fundamental view of the business nor do they care. In addition to some real ethical + legal questions, I think the bigger money is made in looking for long term longs.
• It would be incredibly naive and intellectually arrogant to dismiss the possibility that my thesis is NOT shaped/coloured by an US-centric view of investing. A US-centric view of markets, blind to the experiences/history elsewhere, is dangerous. Macro matters.
• I think if you take my thesis, that “The best kept secret of short selling is to go long, with a long-term orientation” to its natural limit, you approach global macro. I think global macro is the ultimate expression of this thesis.
• In practice, it is often difficult to gauge what the sum total and incremental doubt/skepticisms are, embedded in current market prices.
• As much I love to joke about it, I am not implying that short sellers should stop shorting stocks, and become long only investors. Far from it. The short sellers needs to continue practicing short selling precisely because the practice of short selling can make the short seller a competent - maybe even dangerously good - long investor.
• It is said that “being contrarian is not sufficient - you must also be correct” - to which I would add this corollary: “Being skeptical of skepticism is not sufficient - you must also be correct”