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Retail Investor .org |
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THE UPSIDE OF SHORTING STOCKS IS LIMITED TO THE STOCK PRICE ... FALSEYou hear portfolio managers of long-only mutual funds saying "The upside of shorting stocks is limited to the stock price".... right after they say "Losses from shorting are unlimited". They are hoping to convince you that you SHOULD NOT WANT to short stocks. Why? Because they are not ALLOWED to short within their portfolio's mandate. So is shorting stocks a valid strategy? What matters to any investor is the dollar $$ return he can earn given his limited $$ principal to invest. Shorting requires no $$ principal. No capital needs to be drawn from another opportunity. Percentage returns are irrelevant because every penny of gain (or loss) is a 10,000% profit (or loss). Yes the upside is limited to the dollar value of the stock. But each of those dollars is incremental to the returns being earned on long positions. Yes the downside is unlimited in dollars. And any short position going wrong becomes a larger (not smaller) part of your portfolio. But only if you are silly enough to stick around for so long. Why assume such stupidity and present it as an argument? You must manage your losses whether you are long or short a stock. There are three correct points made against shorting. First is the event-risk. Unlike long positions, a short position when bad things are happening to a company is exposed to the possibility of the company's takeover. The immediate jump in the stock's price goes against your position. Second, the short seller must pay to the person from whom he borrowed the shares, the amount of any dividends paid by the company. So there is a cost to shorting stocks with dividends. Third, in Canada gains and losses are fully taxed like interest (IT479R line 18) - not as capital gains. Why say "no" to an additional $$ return? Why not short the index instead of selling your individual holdings during falling markets? |