The long and the short of it

The Guardian (Charlottetown) - - BUSINESS - BY DAVID PAD­DON

Arthur Smelyan­sky has been an avid re­tail in­vestor since the day he turned 18.

“My eco­nomics teacher was trad­ing and mak­ing more money in the lunch hour than he was dur­ing the week teach­ing us,” he says. “And I couldn’t wait to join him in those ranks.”

Now 35, Smelyan­sky has taken spe­cial­ized cour­ses through the Cana­dian Se­cu­ri­ties In­sti­tute and has done a bit of short selling. But he has ad­vice for those think­ing about get­ting into it.

“It’s riskier than you think.” Short selling in­volves bor­row­ing a stock or other se­cu­rity through a bro­ker. The bor­rowed se­cu­rity is then sold quickly, re­pur­chased af­ter a time, and even­tu­ally re­turned to the len­der.

In essence, the short seller op­er­ates on the premise that the se­cu­rity’s price will fall enough to cover costs and make a profit be­fore it must be re­pur­chased and re­turned.

For ex­am­ple, some­body who “sold short” Home Cap­i­tal shares at $17.71 on April 20 could have re­placed them with shares bought a week later at $8.02, re­sult­ing in a re­turn of 120 per cent, be­fore fees. But that’s an ex­ceed­ingly rare sce­nario.

Crit­ics of short selling point out there’s a limit to how much profit can be made since a se­cu­rity’s price can­not go be­low zero, but there’s the­o­ret­i­cally no limit to po­ten­tial losses if the mar­ket price goes up in­stead of down.

Mar­shall Beyer, who is in charge of cur­ricu­lum at the Cana­dian Se­cu­ri­ties In­sti­tute, said short selling isn’t suit­able for most re­tail in­vestors but ar­gues they should be aware that any given stock could be a tar­get for short sell­ers.

“It’s a mar­ket fac­tor — just like other fac­tors that may im­pact the price of a stock,” Beyer says.

Wuyang Zhao, an as­sis­tant pro­fes­sor at Univer­sity of Texas at Austin, says his PhD re­search demon­strated that “ac­tivist” short sell­ers have a dis­pro­por­tion­ate im­pact on the mar­ket be­cause of their pub­lic pro­nounce­ments.

“You should pay at­ten­tion to ac­tive short selling cam­paigns,” Zhao says, adding that in­vestors should do their own re­search about the stock’s fun­da­men­tals and not blindly fol­low short seller claims.

He notes the un­usual case of El­e­ment Fleet Man­age­ment Corp., a Toronto-based fi­nan­cial ser­vices com­pany, that saw its stock plunge 39 per cent on May 31 af­ter Muddy Waters Re­search an­nounced it had found a new Cana­dian tar­get.

The same day, Muddy Waters - the same firm that ex­posed short­com­ings at Sino-For­est Corp. - clar­i­fied that El­e­ment wasn’t the tar­get and its shares be­gan to claw their way back up.

“In that case, we can clearly sep­a­rate in­for­ma­tion from panic,” Zhao says.

Colin Tal­pos, a re­tail in­vestor who made the tran­si­tion to pro­fes­sional day trader about three years ago, says he doesn’t have a bias for or against short trad­ing.

“I look at the mar­ket and if things are look­ing bad, I’ll short. If things are look­ing good, I’ll be long,” Tal­pos says. “If you’re go­ing to be an ac­tive mar­ket par­tic­i­pant, you should know that mar­kets aren’t al­ways go­ing to go up.”

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