Shorting Stocks? Think Again

You’ve probably heard the old adage to “buy low, sell high.” Some people aim to make money by reversing that order — selling high and then buying low. It’s called “short selling” (or just “shorting”), and it’s perfectly legal. Plenty of people have profited from shorting, but the case against it is compelling.

Here’s how shorting works: If you’re “bearish” on a company and expect its stock to fall, you borrow shares of it via your brokerage and then sell them. You must buy them back at some point, though, to replace the shares you borrowed. If the stock falls, as you’d expected, you get to buy it back at a lower price. Presto — you’ve sold high and bought low.

But over the long run, the stock market — and many stocks within it — tends to rise in value. Even if you find the most hopeless-looking company, with massive debt and shrinking sales, it could still get its act together and stay in business much longer than expected. The company’s employees will likely be working hard to succeed, against the expectations of bearish investors.

Here’s another consideration: If you “long” a stock, buying it the usual way with the expectation that it will increase in value over time, you might lose 100% of your invested dollars in the worst-case scenario. However, your upside is virtually unlimited: The stock could double, triple, quadruple or even increase in value 25-fold.

In contrast, with shorting, your upside potential is just 100% — if the stock falls to zero. If it rises and keeps rising, your downside is unlimited until you “cover” your position, buying the stock back to replace what you borrowed.

Finally, understand that you’ll typically be charged borrowing fees — often steep — on the value of the borrowed shares. And if the stock you shorted pays dividends, you’ll be expected to pay them to the brokerage so they can go to the account from which the shares were borrowed.

You can do extremely well investing without ever shorting a stock.