Can the market model short stocks?
The model can use inverse-stock ETFs under limited and very specific conditions. Why do we allow the model to short? There are periods in history, such as Q4 2008, when inverse stock ETFs are clearly the best option from a probability perspective. We want to keep all options on the table.
The model compares shorting to all other options. If an ETF, such as SH (inverse S&P 500 ETF), is clearly one of the best options and other minimum criteria are met relative to the market’s profile, the model can "short" using inverse-stock ETFs in the conservative side of the allocation. There are many rules associated with using these instruments, including guidelines for dealing with possible intervention from central banks.
The model can use inverse ETFs as hedges against losses in stock ETFs when the market’s profile is vulnerable to morphing into a “bear market look”. Once a bear market is established, inverse-stock ETFs are evaluated in the same manner as any other ETF; they have to earn their way into the allocation based on hard and observable evidence. Shorting is a different and difficult animal, which the model respects and accounts for via guidelines and rules. The model cannot short individual stocks.