I’ve never shorted a single stock, and I don’t believe in short selling as a method to build wealth on the stock market. Instead, I see short selling as a strategy with more risks than rewards for regular investors.
In this post, I’m going to explain why you shouldn’t spend your time looking for short candidates. The big money in the stock market is made in high-quality stocks that go up, not down — here you can learn how to find them. Also, if you’re not familiar with the short-selling method, take a look at this great article📰. Now let me explain…
1.It’s Not So Profitable as You May Think
Reward is limited, but the risk unlimited
Short selling is actually not as profitable as investing in high-quality stocks. Not only that, it’s riskier too!
Say, for example, that you’re not a big fan of Elon Musk and you believe Tesla’s ($TSLA) stock price is insane. So, you consider selling short $TSLA to profit from a possible crash in the stock. As of writing this article, the stock’s trading around $420. Let’s say you open a short position, shorting 1 share. There are two possible scenarios.
- You’re right — Elon disappoints investors, delivering fewer cars than expected, and the stock crashes 20%. Now, the 1 share you borrowed from your broker for your trade is worth $336 (-20%). You return the stock and you have made a quick profit of $80 (not considering fees), not bad.
- You made the same mistake again, you didn’t believe that Elon can do it. Tesla reports earnings results and impresses investors — the stock jumps 20% the next day. And that’s just the beginning. Tesla keeps rising and rising, going up 150% to $1,050 per share over the next 2 months (it’s not that crazy for Tesla). If you haven’t closed your short position yet, you now have to return to your broker ($1,050-$420) $630 — your loss.
The message? In short selling, you can only double your money if the stock theoretically goes to $0, but the potential loss is unlimited if the stock keeps rising.
2.Expenses Can be Huge
🍔Beyond Meat stock-borrow rate had reached a high of 100% in 2019!
When you short a stock, you don’t borrow the shares for free. You pay a percentage fee similar to the interest rate on a loan. These fees can go crazy when there’s a spike in the short interest for a stock. That makes it even more difficult to achieve an attractive return on your investment.
Beyond Meat’s ($BYND) case explains that perfectly. When the maker of plant-based meat went public in 2019, shares surged from the IPO price of $25, up to $234 in the first few months.
The short interest for the stock also surged, and as a result, the stock-borrowing cost jumped even above 100%. If a short seller shorted 1 share for example, after one year he would have to return 2 shares — 1 to the broker and also, to pay the value of 1 share in fees.😳
Many investors often overlook borrowing fees that change daily and depend on the difficulty of borrowing a stock.
3.You Lose your Focus
I don’t know of any billionaire short sellers, do you?
The big money in the stock market is made in stocks that go up, not down. But looking for stocks to go short requires a very different way of thinking than when looking for stocks to go long. Looking for short candidates will distract you from finding high-quality companies to invest in. Successful investors are typically long-only or short-only. It’s difficult to do two opposite things at the same time successfully.
I prefer to be long-only — it’s more profitable, less risky and you become part of companies that change people’s lives.
As always, thanks for reading!🙏
Until next post, enjoy more investing and business content on IG @MillionerInvestor
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