Occasionally, we have guest authors contribute to this blog. The following post was written by Alex Garcia. Alex regularly writes for Contrarian Value Investing, and runs a portfolio which can be seen here.
Shorting is a common technique on Wall Street as investors try to profit from both rises and falls of particular stocks. But one thing I never really understood is why short in the first place.
Definition of shorting according to Investopedia.com
The selling of a security that the seller does not own, or any sale that is completed by the delivery of a security borrowed by the seller. Short sellers assume that they will be able to buy the stock at a lower amount than the price at which they sold short.
Yes, some individuals are successful
Bill Ackman comes to mind as a successful short. I'm pretty sure there are other individuals who have successfully shorted stocks for a living and will continue to do so.
I might not be the smartest man alive, but logic is the main reason I avoid shorting. Here goes:
If I short a stock, my biggest gain will be 100% and my biggest loss could be limitless (assuming I do not get a margin call). On the other hand, if I buy a stock, my gain could be infinity, while my downside is limited to losing my initial investment or 100%. Now that’s what I call controlling my risk/reward.
On January 2007, David Dreman wrote an article for Forbes titled "Short The Exchanges", in which he considered the following stocks: Chicago Mercantile Exchange (NASDAQ: CME), Intercontinental Exchange (NYSE: ICE), and NYSE Euronext (NYSE: NYX). At the time of writing, CME traded at $530. The stock continued its unprecedented run up to $714. The stock is well off its highs, but an individual would have had to stomach a 35% increase in CME’s stock price.