Exiting the Short Goldman Sachs (GS) Position

Shorting stocks is never easy. Many parties would rather see prices increase than decrease so the momentum typically carries prices higher. In an environment where excess liquidity has seeped into the stock market, allowing free money to chase prices higher, the process is more difficult than usual.

Although these difficulties exist, shorting can offer great rewards. When you identify a company whose shares are poised to drop, you can generate return that is not reliant upon the broad market. When those gains arrive at the same time as most stocks are rallying, the positive performance goes a long way toward generating alpha for your portfolio.

Case in point is the short position of Goldman Sachs (GS) in weekly newsletter EPIC Insights. After GS reported third-quarter earnings, it traded in an erratic manner that created an island reversal (black circle) and began a downtrend that pushed the stock lower. With the shares trading at a large premium to book value, the company facing tremendous public backlash, and the shares technically weak, on October 26 we shorted the shares near $180 and then increased the position size when the stock traded below $175.

Since then, it has been a rocky ride. From late October until today, the broad market as measured by my proprietary EPIC Index (EPIC) has rallied 5%. During the same time frame, GS first rallied, then failed, and our short position has delivered a 5% return to our portfolio. While the absolute return is attractive, the fact that this short position should have benefited only from a declining market, we have received over 10% of excess return.

As always, we enjoy looking back at our successes, but clearly realize that we only receive gain in the future. Returning to GS, the stock has declined to my initial price target of $165 (red box). Although the shares could continue lower, I see significant support at $160 (blue line), and have already earned the targeted return. Those looking to squeeze extra profits may want to hold the position to see if GS retests its support. I do not. We have a habit of exiting positions when they reach our target and I see no need to change that approach. The market will present us with more opportunities in the future, and by booking gains now we are prepared to act when new trades develop. I recommended closing the short position in GS as this week's technical trade to my subscribers and they were able to do so before GS posted a strong rally Monday.

Related Stocks:  GS