On shorting

Shorting should be avoided for most people for the following reasons:

·         Could lose more than 100% of the investment.

Actually, in theory, there is no limit. If the shorted stock price rises by 10 times, the loss is well over 10 times the money invested.

·         Need to pay dividends and interest for the shorted stock.

The higher the dividend rate for the stock, the more you have to pay. The experienced investors would avoid high-dividend stocks to short.

Need to pay interest for ‘borrowing’ the stocks to sell. Brokers charge interest rates differently and it could be a huge saving to shop around if you short stocks a lot.

·         Need both fundamental and technical analyses.

From my experience, technical analysis is more important than fundamentals in shorting.

·         If shorting a stock is successful, the gain is subjected to the short-term capital gain taxes which are typically higher than long-term capital gain taxes.

·          Not all the stocks can be shorted.

·         Selling short is not allowed in retirement accounts as of 2013. However, you can buy contra ETFs for a group of stocks to bet against the market or a specific sector, but not on a specific stock.

·         The following sectors are riskier: the drug, mine, bank (unless you know the quality of their mortgages) and insurance sectors. A single drug approval could drive the stock price up by more than 25% in one day.

·         There is no perfect timing. Some stocks fluctuate a lot with no rational reasons. Some stocks could be manipulated.

·         Watch out for short squeezes when the short percentage approaches over 25%. In a nut shell, the stock is running out of shares to be shorted. As a result, it would rise in price especially on any good news.

The above is from my book The Art of Investing.