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Why Short Selling Is A Bad Idea
Our disenchanted markets might have some shorters grinning ear-to-ear at profits, but as Brett Arends says in this Wall Street Journal article, short selling is too risky for most of us.
What exactly is short selling? The concept is fairly simple. First, an investor borrows shares from a brokerage house. Then, he or she sells them to another buyer with a promise to buy the shares back and return them to the broker (at some point in the future). In order to make money, the share price has to fall so that the short-seller can buy back the shares cheaper than the original borrowing price.
Here’s a basic example: Let’s say you think Joe’s Lumber is on its way down the drain. So, you borrow 1,000 shares and short sell them at $10 a pop. That $10,000 is put into your account. Then, a few weeks or months down the road, Joe’s Lumber catches fire (Joe really needs to kick that smoking habit) and the stock plummets to just $2 a share. Now you buy back the stock at the lower price and return them to the lender, reaping $8,000 in profit.
Sounds pretty great, right? Not when you look at it the opposite way. Say the stock jumps from $10 a share to $25? Now, instead of making $8,000 in profit, you stand to lose $15,000, at least. As long as the stock price stays above the initial borrowing price ($10), you’ll be counting losses. Since the shares are borrowed, you don’t just lose money, you owe it. Your losses can be infinite. There are a few variables I’ve left out (i.e. stop-loss, options, etc.), but this is the general picture.
You can see why shorting is an attractive idea right now. Poorly run companies are being exposed by dwindling share prices, and government regulators are having trouble too. To top it off, the bear market we’re in has loads of people dumping stocks, driving prices further down.
As Brett Arends says, it’s better to leave short-selling to the professionals. It’s hard enough to pick a winning stock, never mind a losing one. When you look at the stock market in the long run, it always bounces back. Prices are taking a hit in many areas of the market, but they can’t fall forever. And sure, things may look apocalyptic, but blue skies are usually higher than the storm.
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“Why Short Selling Is A Bad Idea”
What are you talking about? -Seems like this is a website for people that know little (or nothing) about finance, bloggers and readers alike.
If you are short selling and do not understand the risks involved, then Yes, it is a bad idea. BUT WHO IS DOING THAT? I doubt too many people are making investments blindly these days,… or ever. Short selling can be very profitable, but only because it can also be very risky. DUH!. You raise an obvious point like it is some overlooked deep insight you had. Take a finance course before trying to write about it.
Seems like all most bloggers do is re-package conventional reporting with an opinionated spin to satisfy their egos; Always lacking real content or original thought.
OH, and when you say “Our disenchanted markets…” you are using a word which you do not know the meaning of.
Disenchanted, when used as an adjective means free from enchantment or illusion. MOST people would say the markets are ALWAYS full of illusion, A.K.A. why you cannot predict what the market is going to do. You imply that the markets are transparent and easily interpreted, which, COUGH, THEY ARE NOT!. In fact, they are extremely volatile, resulting from widespread speculation. This is generally the case. Maybe you thought ‘disenchanted’ was just a cool sounding word you would throw in there to sound like you know what you are talking about, which you don’t…Embarrassing
Hey there -
Well, you have the right idea when you say, “this is a website for people that know little (or nothing) about finance.” Our goal at FiLife is to educate our users about how to get on the right financial track while recognizing that every ones’ understanding of personal finance varies. We take the attitude that we’re all in this together. In relation to this particular article, we felt that short-selling is a topic that many people hear about, but usually isn’t properly explained. While you seem to have a somewhat informed view of the matter, others might not.
You are certainly entitled to believe that “all most bloggers do is re-package conventional reporting with an opinionated spin to satisfy their egos” however, at FiLife, we try to check our egos at the door. We often try to point readers to helpful personal finance articles that we’re publishing on the site, and to explain some of the basics when they need a better explanation.
Finally, our reference to ‘disenchanted markets’ merely meant (but was perhaps poorly conveyed) that many markets are seeing losses, which makes it opportune for short-sellers.
Although your feedback was far from positive, we appreciate it nonetheless, and hope that you can use FiLife to better your personal financial needs in the future.
-Colin Constantine