New Trade: We're Taking Partial Profits on our TSLA Short (Even Though We'd Rather Add More)
Today we are taking partial profits on our Tesla (TSLA) short and moving the risk point on the remainder of the position to breakeven.
Here are the details, with position management commentary to follow:
Taking one-third partial profit (buying to cover one-third) of short TSLA position at market price and moving risk point on remainder of position to breakeven
Tesla had a fascinating earnings call this week. We have plenty to say about that, likely in next week's model portfolio update.
In the meantime, though, we are taking partial profits here as a function of psychological risk management.
Truth be told, we don't want to take profits here; all things being equal, we would rather short more. The outlook for Tesla is so dire, and the bullish rationale so detached from anything resembling reality, there is a part of us that wants to short the daylights out of it.
And yet, taking partial profits is a logical compromise, from a risk-management perspective, because the possibility exists that die-hard bulls will succeed in ramping TSLA shares again based on the latest injection of false hope from Elon Musk.
We're not saying a share price ramp in TSLA is an overwhelming probability, or even a high probability, from here. It is more like a 33% probability — a one-out-of-three chance — that Tesla bulls put together enough of a run to create new headaches for bears.
That is enough of a risk, though, that taking partial profits here provides a kind of psychological balance that makes it easier to stay with the position.
If Tesla bulls do their thing and push the share price higher on a temporary basis, having taken some profit off the table will make it easier to ride out such an event if it occurs.
That mental staying power could then facilitate an opportunity to short more — to add more to the position — after the countertrend rally shows clear signs of petering out.
So, in a sense, we want to take some profits here for peace of mind... and to put more on again later if need be.
Taking partial profits is also a compromise in light of the possibility — and this is more likely than not — that the bulls fail from here, and TSLA just keeps declining to new lows. If that happens, it would be better to have a full position rather than a one-third-reduced position.
But such an event would also come with the satisfaction of seeing reality overcome delusion as the true-believer Tesla cult comes undone.
In another position-related note, we had considered taking partial profits prior to this week's earnings call, but didn't. The reasoning was that Tesla is almost out of gas in terms of getting investors to believe false promises, and Musk has been an erratic disaster on earnings calls before.
That call, too, was a matter of strategic compromise. Say we had taken one-third profits prior to the earnings call, and then Tesla had dropped another 20% (which it realistically could have, for reasons we'll discuss next week).
If that had happened, taking partial profits on a high-conviction position before an anticipated large post-earnings drop would have been seen as the frustration-inducing move.
So we decided to wait for earnings to come out. And then, the day after, the post-earnings share price pop — akin to a $5 bottle of grocery store champagne — looked like it had a good chance of fizzling out.
And even now, TSLA is below its 50-day moving average (the green line on the chart below) and hasn't managed to retake that average, or to break its downtrend.
The price action of Thursday, April 25 (yesterday), is what tipped us into the camp of taking one-third partial profits today.
As a counter-scenario, say that TSLA had declined sharply on Thursday, and made progress toward closing the gap created by the earnings pop as opposed to finishing at the highs.
If that scenario had occurred, we would have just kept the full position.
As it stands, though, the ability of TSLA to rally enough to close at its highs on Thursday became a tipping-point factor in favor of the bulls possibly making a run again — not with an overwhelming degree of probability, as we stated earlier, but enough of one to want to guard against it with some profit-taking.
It's a knife-edge kind of decision, but the balance of probabilities here is what makes it that way. When a decision is in the realm of 55-45 or even 51-49 — as it was here with "keep the full position" versus "take some off the table" — a subtlety like a single day's price behavior in the immediate aftermath of an event can be the deciding thing.
We walk through the logic here as a useful exercise in thinking about position management. There are multiple factors juxtaposed: conviction in the overall position; risk of adverse price movement; finding a balance between wanting to maintain a good-sized position and wanting psychological buffer (via profit-taking) in the event another short squeeze occurs; and so on.
It's a subtle process because it has to be — there are too many factors involved for a simplistic approach to work. As a parallel, think about the NFL draft going on right now, and the strategic calculus that goes into choosing which player, trading picks today for better picks in a future draft, and so on. As Denzel Washington's legendary bad guy said in the movie Training Day, "this [is] chess, it ain't checkers!"
It isn't chess out of a desire to embrace complexity... it is chess because certain things have to be chess (i.e. a complex game rather than a simple game) in order to get them right.
As Einstein said, "It can scarcely be denied that the supreme goal of all theory is to make the irreducible basic elements as simple and as few as possible without having to surrender the adequate representation of a single datum of experience." Or as the popularized summary goes, "things should be made as simple as possible but not simpler."
NFL draft aside, nobody would want a paint-by-numbers surgical procedure, a paint-by-numbers corporate business strategy, or a paint-by-numbers approach to geopolitics. Irreducible complexity inherent to a process is often an inevitable required byproduct of aiming for a high-bar outcome or result.
But the complex-system aspect of things is also what makes it interesting — if one enjoys the strategic-game-playing aspect of this stuff, which for us is what makes it fun — and furthermore what generates the potential for large payoffs.
The greater one's ability to intuitively grasp the subtleties of position management — the sizing, the psychology, the probability assessments, the real-time reactions — the greater the corresponding impact on one's ability to seize the moment when it matters most, and in so doing generate a level of compound returns (in absolute dollar terms, not just percentage terms) that 95% of market participants cannot.
Until next time,
Justice Clark Litle Chief Research Officer, TradeSmith
TradeSmith is not registered as an investment adviser and operates under the publishers' exemption of the Investment Advisers Act of 1940. The investments and strategies discussed in TradeSmith's content do not constitute personalized investment advice. Any trading or investment decisions you take are in reliance on your own analysis and judgment and not in reliance on TradeSmith. There are risks inherent in investing and past investment performance is not indicative of future results.
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