The short-selling of stocks has achieved almost-mythical status among individual investors. We hear, all the time — on CNBC, FOX or from brokers or financial gurus — that “The shorts did it,” “They are caught in a short-squeeze,” “The shorts are bringing it down.”
Mention the word “short” and you can almost hear Darth Vader breathing through his mask. But all myths are based on some facts, so let’s look at them:
- Shorting is an integral part of the market, and short-side investors provide liquidity to the stock market.
- At some point, markets go down. At some point, stocks go down. These two things are certain.
- Stock prices drop faster than they go up (fear is far stronger than greed).
- Short positions pay off faster — MUCH FASTER — and with larger gains, often spectacular gains, compared to long positions.
- Shorting can happen in many ways: The outright shorting of a stock, buying puts, buying LEAPS, selling covered calls, selling covered LEAPS and so on.
- Shorting has become simple and easy to execute using put option contracts and LEAPS for thousands of stocks.
- Shorting stocks no longer means margin calls, frozen capital and night terrors.
- Investors can short the entire market, a market segment such as biotech or semiconductors, or an individual company.
You do not need to be a day trader or watch your stocks hourly to go short, but you do need to understand the potential risks and rewards of shorting and how that fits into your overall investment and trading strategy.
The bottom line: there is a great deal of profit to be made in playing the short side. Shorting is an excellent way to make money when there is bad news. And this may be the best reason for you, as an individual investor, to explore what many call the “dark side.”
If you are a long-only investor, when you know bad news is coming, the most you can do is sell or sit back and watch. Not so if you go short — shorting returns the initiative to you, turning you from passive to active, and enables you to profit when the edge you have is based on negative, not positive, news or insight.
If you enjoyed this article, check out Michael Shulman’s “What is a Short Stock or Option Position?” and “Making a Short Trade.”