An ego is dangerous when investing. We all have difficulty admitting we are wrong in every walk of life, it’s no different when it comes to the markets. This is especially true for men. Guys, you know it’s true. A steadfast opinion can crimp your overall returns. This is especially true when it comes to short positions.
Most people shouldn’t short a stock. There, I said it. I’ve done it before with mixed results, but it hardly seems worth the hassle. For every Jim Chanos, there’s 100 others who should never do it. Just do a web search on “How I lost money shorting stocks” and you’ll discover some of the drawbacks of shorting stocks. I suspect you’re not running a hedge funds your’e reading this, no need to pretend to be to satisfy some sort of animal spirit.
I don’t have a problem admitting that Jim Chanos and others like him are smarter than me. Maybe you should too and join me in the realization that “not long” is many times the best position in a stock we view as overvalued.
That advice is a bit uncommon for good reason. Brokers want commissions. Short positions inherently cause more trading which leads to more revenue for the broker. Folks that are selling subscription or other services like to tout short ideas because it can give credence to the service if the short plays out. Meanwhile, some don’t even short the idea they are touting. The only free lunch in investing is collecting fees, commissions or subscription revenue. My hat is off to all that manage to do this. Some “eat what they cook” and provide solid advice for a reasonable cost. Others do not.
I’ve met plenty of affluent people over the years whether they were parents of college classmates, pro athletes, real estate investors, what have you. You know the one thing I never once heard out of any of them? “Boy, I made a ton of money shorting (Blank) stock. It really set up me for the wealth I’ve built today.” Not once.
That’s not to say you can’t still benefit from a short analysis or a short bias you have on a stock. Sidestepping land mines can be very beneficial when it comes to overall returns. LinkedIn(LNKD) proved to be fairly resilient for quite some time. A person could have driven themselves crazy shorting it based on the fact that no one really seems to enjoy using the service and that the value of the company was over $30 Billion dollars at one point. One day it can go “boom” but it can be a long and arduous process to do it.
One day your instincts can be proven correct. Waiting for that day can be costly. Buy puts? Let me introduce you to time decay. A put spread? Here’s how to pay to cap your gains. Probably the “safest’ strategy is to short the common of an issue you don’t like and buy a call above the current value which protects you from a loss beyond that strike. Here again though, you’re paying for that protection, limiting gains and it’s not indefinite, meaning you might have to buy the protection while your short “plays out”, if it ever does.
“I’ll just put a stop loss in, no problem.” If you can guarantee me there won’t be a “flash” incident in the market, that could work, but I wouldn’t count on it. For all the talk of flash crashes even flash rallies, there’s rarely talk about flash crashes or spikes in individual stocks. They are not all that uncommon.
I haven't’ even mentioned how a stock can only go to 0 but can, theoretically, rise forever. That’s not a recipe for a good night’s sleep. If you can find a short that already doesn’t have a high interest and watch it closely, it can go well, but how often will that happen? A large blue chip company isn't going to run away from you if you’re short but how much money is their to really be gained there? Is it really worth the time and effort?
The fancy Wall Street parlance for this is “Opportunity Cost” if you want use that.
I’ve had some luck over the past few years shorting and buying puts on IBM (IBM) as has many people, but it’s not close to outperforming any of my longs. Did my focus on IBM keep me from finding another long that would have outperformed my IBM short? Maybe a company that’s been taking from IBM over the past few years would have been a better long as opposed to being short IBM? I suspect yes is the answer.
If the average person can be pushed to cash in a 401K by a string of bad headlines it’s not going to take long to cover for a loss on one headline that works against you on an individual short. How convicted can you be after all? Just don’t be long. You’re not selling anything or trying to ink a book deal. You’re investing for retirement, a vacation, a college education for your kids, there’s no need to be a hero. Avoid stocks that you believe to be overpriced and look for longs that play into that thesis.
Remember, these hedge funds that have these elaborate short positions using options and stock have an advantage you and I don’t. They’re not using their own money. If you all want to give me a coupe hundred million dollars, I can find a long list of stocks to short and then just shrug my shoulders, collect my 2% and go about my day if they don’t work out. I’m happy to do it. I won’t hold my breath.
As is the case often in investing, doing nothing is probably the best option. Don’t rob yourself of other gains in your portfolio to finance a short idea that’s probably doing nothing more than soothing your ego.