Feels like every man and his dog is a Long/Short investor on Twitter. And short-sellers like Muddy Waters Research are all the rage.
But why might short selling be a bad idea? Why do I think short selling is whack?
From risk vs reward, irrational markets, and the stress involved, I hope I can outline why short selling might not be all that it’s cracked up to be.
What is Shorting?
(Feel free to skip this section if you’re familiar)
The act of borrowing someone’s shares, selling it, and hoping the share price goes down.
For example, you want to short Amazon. You’ll borrow (off your broker) and immediately sell $100 worth of Amazon stock.
Say in a weeks time Amazon stock is now $90 and you want to close your position. You buy it back, pocketing the $10 you got from selling at $100, and buying at $90.
You’ve gone, +$100 (Borrowing the share and selling it).
Then, -$90 (buying it back for the original stock owner after the price decline).
Your profit? The $10 decline.
Still unsure? Watch this 3 min youtube video.
Risk vs Reward
The tail risk and tail reward, in my opinion, just has zero appeal to me.
Say a black swan event happens after buying a company’s shares. I’ll either lose all my money invested (but no more than my initial capital). Or I make 5, 10, or 20 times my initial investment.
A black swan event when shorting is much more detrimental. You’ll make at best 100% return when shorting a stock. If it skyrockets you’re on the hook for unlimited losses. You literally get bent over big time.
The odds feel much more in my favour when buying and holding.
I make the worst share purchase of my life? It goes to zero. And I lose 100%.
I make the worst short of my life? Let’s say it’s Tesla. It goes up. And up. And I lose way more than 100% of my initial capital.
My risk tolerance is at the lower end of the scale. So the idea of shorting to me just doesn’t interest me in the slightest.
Markets are Irrational
You might find the perfect short candidate. Crazy overvalued with crap business economics. Doesn’t mean it’s going to zero anytime soon. Or even at all.
See this guide to shorting shitco’s
Shorting might be harder than you think. ¯\_(ツ)_/¯
Dealing with Mr Market’s irrational behaviour is hard enough as a long-only investor. Betting against the momentum of irrational, rising markets just seems like it should be in the too hard basket.
Betting Against Long Term Trends
I believe in a better tomorrow. It’s almost human nature to improve upon what already is. What’s a common goal among parents? To provide a better life for their children than what they had.
And I’m not sure that’ll change anytime soon.
So betting against the long term trend of rising economies and markets seems like a losing battle.
“Without a saving faith in the future, no one would ever invest at all. To be an investor, you must be a believer in a better tomorrow.”
Short Term Investment Horizon
Shorting, is by nature, a shorter-term bet.
Especially when compared to buy and hold investing where you look to hold for 5+ years.
You don’t short a company hoping it leaks money for 5+ years. You’re counting on a fairly quick reversal in stock price.
I won’t say I’m against short term investments. But there better be a bloody good reason. And given my thoughts so far, short selling is about appealing as prune juice.
Greater Research and Conviction
When investing you obviously want to be as thorough as possible. That should go without saying. But given all the previous risks I’ve listed with shorting, I would want to be twice as thorough.
You wouldn’t go short unless it was a near certainty. You’d want to be 110% sure that the ShitCo you’re shorting is destined for zero. Because the risk of being wrong can be quite costly.
In investing and in life, I like to minimise stress.
All the reasons listed above, seem stress-inducing. The insane research and conviction needed. The constant monitoring. The risk versus reward factor.
It’s just not worth it. At least in my eyes.
So in order to keep my sleep habits, I don’t do it.
Life’s too short to short.
I think I’d rather just research ideas that have a chance of generating long term returns.
Too much risk, time and effort. For too little reward. It’s as simple as that for me.
I’d rather sleep easy.
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