Time to short Facebook

With signs that Facebook may be near saturation point, Matthew Partridge proposes shorting it. Plus, he updates on his trades to date.

When social-media group Facebook first went public at $38 a share, many people thought it too expensive. Those doubts looked sensible when the company lost nearly half of its value within a few weeks of trading. Yet since then the naysayers have been proved dramatically wrong anyone who bought Facebook at its lowest point of just above $17 would have multiplied their money near-tenfold in less than five years. Even if you had invested at the list price you would have made more than 36% a year on your investment. Now its CEO and founder, Mark Zuckerberg, is being semi-seriously touted as a presidential candidate.

However, Facebook's best days may be behind it. Recently the company has been accused of everything from facilitating terror to affecting the outcome of the 2016 presidential election. While much of this is overdone, governments around the world are now treating Facebook as a serious publisher, and as a result, are demanding proper oversight. Facebook has already promised that in the near future all political advertisers will have to comply with US regulations on such broadcasts. And while some new rules may be harmless, or merely inconvenient, others strike at the heart of Facebook's business model. One big bone of contention is the way it allows advertisers to target users based on their preferences which is, of course, Facebook's main draw for advertisers. Any restrictions on the use of user data could seriously impact the bottom line.

There are also signs that Facebook may be near saturation point. In the two years before it listed, user numbers doubled from 500 million to a billion. It's taken five years for the number to double again to two billion. Given that most of the remaining users are in very poor countries (and so of less value to advertisers), it's going to be harder to find room to grow, something that it desperately needs to do to justify trading at 29 times its 2017 earnings. China also shows no signs of lifting its 2009 ban on Facebook.

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Zuckerberg (who currently owns just under 30% of the company) plans to sell 75 million of his shares, which seems a big red flag, although he insists he is doing it to raise money for his foundation. The fact that Zuckerberg also seems to be dipping his toes into politics is also bad news, as it suggests that his attention is focused away from his company (see page 12 for more on the danger of celebrity CEOs). We'd therefore suggest shorting Facebook at $164.46 with IG Index at £0.24 per $0.01, setting a stop-loss at $200. This limits your downside to £948.90.

How are we doing?

Excluding our latest recommendation on Facebook, we have eight open bets. Six of our positions are long (John Laing, IG Group, Petrobras, AA, Barclays and Renault). We also have short positions in online grocer Ocado and electric-car group Tesla. Our position in Petrobras, which is making a profit of around £269, is our biggest winner. IG Group, which is £168 in the black, and John Laing, up £107, are also big winners. Unfortunately, they are counterbalanced by AA, which is already £250 underwater, and Barclays down £183. Renault is also down £44. Overall, our long positions are essentially breaking even with a small profit of £66.

However, our short positions are doing poorly. While Ocado's share price has fallen in recent days, it is still 33p above the price that we recommended shorting it. If you had followed our recommendations to short it at £4 per 1p, you would be down £132 at the moment. Meanwhile, at one point this month, Tesla reached a peak of $385, which would have pushed us £668 into the red. Fortunately it has since fallen back to $345. However, that is still above the $329 that we originally suggested as an entry point for shorting it, which means you would still be £188 behind. Overall, our combined shorts are £320 in arrears, which means that our eight positions are losing £254.

As a result, I'm going toclose our short position in Ocado. I still believe that the company is overvalued and faces the threat of competitors muscling in on its business. However, I think it is unlikely to fall in value in the short term while it continues to grow at a strong rate. Having held the position for over six months, I feel it is now time to move on. Similarly, to balance this, I'm also going to suggest that youclose the long position on John Laing, which we've also held for a relatively long period.

Trading techniques: how to use moving averages

Many traders, especially those who bet on short-term price movements, rather than trading on longer-term fundamentals, use price charts to anticipate price changes. Most charting systems are based on the idea that stock prices exhibit momentum, so if a stock is rising, it is more likely than not to keep doing so. (There is some evidence for this a 1993 study by Narasimham Jegadesh and Sheridan Titman found that stocks that did the best in the short run will go on doing so.

One way to determine whether a stock has momentum is to plot its price against a moving average of its previous prices. If the stock is higher than the moving average then it is said to have positive momentum; negative if it is falling.

The length of moving average used varies, with traders typically using one or more of between 10 and 200 days. Some traders favour an exponential moving average, which gives a greater weight to prices in the recent past. Traders also differ in how they use moving averages. Some use it as a multi-directional tool, buying a share when its price goes above the moving average (or when a short-term moving average crosses above a longer-term one) and shorting when it falls below. Others use it more defensively, going long when it goes above the moving average and cashing out when it falls below. Just be aware that slavish adherence to the indicator can encourage over-trading Wharton's Jeremy Siegel found that the transaction costs generated by using a 200-day moving average to switch in and out of the Dow between 1881 and 2011 would have more than wiped out any profits.

Dr Matthew Partridge

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri