Shorting a Stock - A Warning to Traders

Sep 08, 2020

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Short selling sounds so logical. You find a stock that you believe is heading lower, and you sell it short. With so many underperforming companies on the exchange, you’d think it was an easy way to make money. Backing a losing stock to keep losing naturally seems like a smart bet.

But things are rarely as easy as they sound. For many people, short selling only leads to losses, and for some it ends in disaster. In this video, I’m going to tell you four reason why short selling doesn’t work for most people. I’ll also tell you about a trader who completely blew up his account.

Now, a quick reminder, if you’re new to my YouTube channel, make sure you hit the subscribe button below the video, and then click the bell icon to get notifications when I release new videos.

Okay, so when people think of shorting, they offer think of this man… George Soros. Soros became a household name in 1992 when he shorted the British pound. In a single day, he made $1 billion.

But I’m not going to focus on Soros in this video. That’s a story for another day. Instead, I’m going to tell you about a guy called Joe Campbell, or Trader Joe as he became known. Now this isn’t his real picture, but I think it captures how most short sellers end up feeling [see video for images and story].

You know, headlines of billion dollar wins capture the imagination. And I the think reports of these amazing stories fuel much of the interest in short selling. But it’s stories like Trader Joe’s that are closer to many people’s reality.

So why is shorting so hard?

Well there are 4 primary reasons.

Reason #1: Market Volatility

A falling stock tends to zig-zag lower. This can make it a lot harder to hold onto a position.

Reason #2: Funding cost

If you're going to trade short, you're going to have to pay a cost to hold that position - and that makes it more expensive to actually put the trade on.

Reason #3: Takeover risk

This is what happened to Trader Joe, he came in one morning & the shares have shot higher overnight. These are the sorts of things you're up against when you try to short a stock.

But the biggest issue of all is reason #4… 

Reason #4: The maths of shorting a stock

The best result when you buy is infinite. This leads to the concept of asymmetrical risk. And this is at the core of successful trading and invest. If you’re going to make money over the medium to longer term, then you need to ensure that the risk you take, produces a return that far exceeds the risk taken.

So if you risk a dollar, you might want a potential payoff of $3.

Now, think back to Trader Joe. He lost $143k chasing a best case scenario of $37. Now he didn’t know these were the parameters in advance. But that’s the risk with shorting. If you’re not careful, the risk/reward profile can get seriously out of whack.

Having said that, shorting can be a useful strategy. And if you use it wisely, then you can add value to your account. I’ll tell you how I use short selling… I use it for hedging. If I believe the market might fall, I can protect the value of my portfolio by taking a short position. I’ll typically do this through the futures market or through an exchange traded bear fund.

But as a standalone profit strategy, shorting isn’t for most people. You see, successful trading is about putting the odds in your favour. You want to use a process with a strong payoff potential. And if you can stick to that system over time, the probability of success is on your side.

I believe shorting for profit makes this harder to achieve. That’s because shorting often has a lower payoff potential. And this is largely due to its less favourable risk/reward characteristics. You simple can’t make the same sort of money as you can when buying.

In my next video, I’m going to explain the difficulty of shorting stocks when the market is trending lower. I’ll also tell you who wins in the bear market… the answer might surprise you.

To get a notification of its release, make sure you hit the subscribe button below and click the bell icon. You can also get a free strategy report from my website www.motiontrader.com.au And if you enjoyed this video and thought it was valuable, then please click the like button and share it with your friends. Thanks for watch, I’m Jason McIntosh, and let’s find some trends this week.

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