If you listen to financial news, you may have heard about this thing called "short selling." Perhaps you heard about billionaire hedge fund manager Bill Ackman's $1 Billion short position against Herbalife the nutrition company. Short selling may sound fancy and it sure sets the financial media abuzz whenever a famous investor does it publicly. But it may not be the best decision for the individual investor. Let me explain why I never short a stock...
What is short selling?
Short selling, or shorting, is when an investor borrows shares of a company and sells them at the current market price, hoping to buy the shares back later at a cheaper price and return them back to the lender. If the price of the shorted stock were to increase in the interim, the investor would lose money on the short position. In essence, to short a stock is to bet against a company.
Why I don't do it...
- Limited benefit, unlimited risk - When you purchase a stock, your losses are limited by what you paid for that position. For example, you buy $100 worth of a stock and the company subsequently goes broke, you lost $100. But the potential benefit is infinite as the stock can go as high as the market lets it. To short a stock is the exact opposite. In our example, if you short $100 in a stock, the maximum amount you can gain is $100 if the stock goes to $0, but the potential loss is infinite.
- Bad feelings - To short a stock is to actively bet against a company. As much as you may disagree with the missions of big oil, big tobacco or other "evil" companies on a philosophical level, you probably won't wish ill on the people they employ once you realize they have jobs, families and ambitions just like us. I simply don't have enough hate in me.
- It's really not all that fancy - There are a lot of Type A personalities among White Coat Money readers. As such, we are often attracted to things that sound exotic, complex and challenging. Unfortunately, as you can see above, short selling is really none of those things. It is not difficult to grasp conceptually, neither is it reserved for members of an exclusive club.
These are the reasons why I never short sell a stock. And in my opinion, most individual investors probably shouldn't either. Perhaps one day I will develop enough conviction to bet against a company, but for now I'm happy "going long" on my investments.