What the High Level Investors Needs to Know about Shorting - dummies

What the High Level Investors Needs to Know about Shorting

By Paul Mladjenovic

“Buy low, sell high” is such an ingrained principle that it needs no explanation. But shorting is essentially the opposite, and therefore it becomes a head-scratching lesson even for some intermediate investors.

Before you dig into the world of shorting stocks, here are a few essential points to keep in mind:

  • Making money shorting stocks is not a bad thing, morally speaking. It’s not like you’re burning down Grandma’s house and looting the knitting supplies she uses to make sweaters for orphan puppies. You are (or are seeking to) make money from the (downward) market gyrations of a stock; you aren’t causing anything to drop. You didn’t cause any grief to the underlying company, and you aren’t cheering for any firm to suffer. The downs of stock movements are part of what makes it a market.

  • Over the long term, markets tend to have an upward bias. Look at any long-term chart (say, 10 or 20 years or longer), and you see that the stock market tends to move upward (in a zigzag manner). That’s why shorting stocks over an extended period of time tends to be a losing strategy. Shorting can mean phenomenal profits for you in the short term, but it’s very risky beyond that.

  • Stocks aren’t the only things that you can go short on. You can also go short on exchange-traded funds (ETFs). This is one of the similarities between stocks and ETFs; both are generally marginable, optionable, and shortable, and trading can be done with the usual brokerage orders.

    What if you think that industry X is in terrible shape and you’re very bearish on it, but you just can’t seem to find the right stock to short? Consider going short on industry X. Do your due diligence (research the industry to see whether your bearish views are confirmed) and find an ETF that mirrors that industry.

    By the way, if you do want to short a particular industry (or an entire sector or a type of investment such as a commodity, for example), then consider inverse ETFs. An inverse ETF is definitely speculating, but it’s much less hazardous than shorting.

Because going short on stocks has greater risks than going long (the practice of buying stock, holding onto it for a while, and hoping its value goes up), beginning investors should avoid shorting stocks until they become more seasoned.