Bearing rules for selling short

1. Never fight human progress. I want to ride secular waves, not fight them. Tech and health care are mostly off limits from the short side. There are always exceptions, like Valeant Pharmaceuticals and Tesla, but if the stocks are simply overvalued, we’ll be a spectator. If anything, I’d rather be long clear winners, even if I have to pay up a little. This is a natural hedge against our short position.
2. Short companies highly vulnerable to the cyclical event. These are typically dependent on cheap credit in one way or another. They also tend to drink the Kool Aid during the boom and take on too much leverage.
3. Short consumer fads… when the stocks are priced as if growth will continue indefinitely. Canada Goose might be an example today, but it’s only on my radar for now.
4. Only short a stock if you see a path to a potential 75-100% decline. Otherwise, the risk/reward isn’t worth it. (There is a lower bar for bonds, but the same risk/reward formula applies.) That means the business will be impaired, which usually involves intensifying competition and indefensible moats. The ETF business is a good example.
5. Compartmentalize risk. Evaluate every position on risk/reward. Don’t assume your hedges will work (they often break at the most inopportune times). Don’t allow one losing position to swamp the rest of the boat.
6. Big trees will underperform. $1 trillion market caps of AMZN and AAPL are a good example. This doesn’t necessarily mean they qualify as impaired businesses or stocks that can go down 75-100%, but knowing they are highly likely to underperform over the next decade (after all, trees don’t grow to the sky) is valuable information. E.g., this could be the pin that pops the passive investing bubble.

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