Short sellers are often cast as the big bad villains on Wall Street.

After all, they are the all knowing, short term traders placing big money bets hoping your portfolio goes down in value while they turn a quick profit.

Unfortunately, for all of the bearish sentiment they spew and openly spout off why your favorite stock is about to take a quick nosedive into the abyss (often on major news outlets like CNBC or Bloomberg), they actually provide a valued service by preventing the stock market from getting too far ahead of itself.

After all, for every Yin, there is a Yang.  A Vishnu for every Shiva.  A Batman for every Joker!

But just because you enjoy playing the villain, or believe a certain company is destined to bite the dust, it doesn’t mean you have the knowledge, skill or time to play the antagonist of the investing world.

Long Term Reasons You Should Never Short the Stock Market

1. The upside potential for a stock is limitless.  Theoretically, a stock can go from $1 to infinity over a long enough time line.  This assumes the company remains in business of course.
2. The best return possible is to double your money.  Whereas the upside of a stock is limitless, the best you can ever hope to do by shorting a stock is for that company’s stock to go to zero.  Of course, this almost never happens.  For example, if you buy a stock at $100 it must go to $0 to see a 100% return, but you’re subsequently capped at 100%.
3. History proves the markets like to go up, not down.  If you’re short, you’re likely on the wrong side of the long term trend of American stock market indices.  Only a fool plays chicken with an oncoming train.
4. You’re betting against growth and progress.  Companies (even nation states) pride themselves on growing their bottom line a few percentage points every year.  They make it a point to meet their growth projections in hopes of attracting new customers, gain clout within their industry, and of course, increase the value of their stock options.
5. Regulators will eventually reinstate the Uptick Rule.  The uptick rule was implemented in 1938, but repealed in 2007, to prevent short sellers from creating a shark-like feeding frenzy driving a stock down unfairly and to prevent stock price manipulation.  This was grossly evident in during the collapse in financial companies in late 2008, and will almost certainly be reinstated making it harder for short sellers to make a buck.

Short Term Reasons You Should Never Short the Stock Market

1. Macroeconomics is the stock market’s master!  You can take the worst stock in the world, and on a day when the market is up 2% or more, you stand a good chance of losing money.  Especially if that stock is included in an index or ETF.
2. You are attempting to time the market.  Traders will say you can absolutely time the market.  Buy and hold investors will say you’re a fool for trying to time the market.  Lots of evidence says the buy and hold investors are correct a majority of the time.  If you’re trying to time the market in one big swoop, be prepared to take your lumps because you can go broke very quickly trying to short a market that won’t go down.  If you get lucky and time it correctly, never celebrate because karma has a nasty tendency of remembering who you are.
3. Getting caught in a short squeeze.  A “short squeeze” is trader lingo for having an open short position in a stock, something good happens for the stock in question (e.g. a positive press release), and the short sellers quickly rush to cover their positions.  Short sellers must actually buy the stock to cover their position, so the quick surge in buying activity pushes the stock even higher.  Short sellers can quickly lose 5-15% in a single day if caught in a short squeeze.
4. Mergers result in a stock price premium.  Companies work incredibly hard to keep a merger or buyout top secret.  When it occurs, the share price of a stock you just shorted can skyrocket 10% or more (depending on the buyout price) within seconds.
5. You must become an active trader to short stocks.  Short sellers are generally very active traders and move into and out of the market on a very frequent basis.  So if you want to short stocks, be prepared to trade frequently (e.g. spend more money on broker commissions) and increase the amount of time you’re sitting in front of a trading screen.

Hopefully, these ten reasons will make you think twice before hitting the short sell button.

Of course, the expert option traders will give me grief for not mentioning put options are cheaper and carry less risk when getting short on an individual stock or index, but options trading really isn’t the scope of an investing 101 blog.

Did I leave anything out?  Do you have other or more significant reasons you refuse to become a short seller?  Comments are welcome!

by renaissancechambara

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