Why Shorting Falls Short

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Is shorting stocks a good long term investment strategy?

When compared to traditional stock investing, shorting falls short.

What is Stock Shorting?

Shorting a stock can be considered the opposite of investing in a stock.

When investing in a stock you are making a bet that the stock will appreciate. However, when shorting a stock you are betting that the stock will fall in value.

How Do You Short A Stock?

To short a stock you borrow the stock from someone so that you can immediately sell it. However, after a period of time you have to return the stock to the original owner. During the period of time when you first borrowed the stock and the time when you have to return it you are betting that the stock will fall in price. This will allow you to buy the stock back at a lower price than you sold it at, allowing you to pocket the difference.

Why Does Shorting Falls Short?

Shorting falls short when compared to traditional stock investing over time.

Why?

Because even if you are correct that the stock you are betting will fall, the most you can earn is a 100% return on your money.

Shorting Example:

Let’s say that you believe that Elon Musk is a fraud and that Tesla is going to go to zero.

You decide to short the stock. You borrow a share of Tesla from someone at yesterday’s closing price of $297.18 per share in the market and sell it.

It turns out that you are correct and Tesla goes bankrupt. All of the common stock holders are wiped out. You just made $297.18 on your bet… A 100% return.

But what if it turns out that Elon Musk is a magical genius and somehow Tesla becomes profitable generating an operating profit…

He realizes his vision of selling solar panels profitably that power the Tesla EVs and the Tesla ecosystem becomes self-perpetuating…

Through the lens of its position as a vertical manufacturing colossus, Apple decides it sees something it needs in Tesla and agrees to buy Tesla to Apple for $200 billion, or 4x Tesla’s current market cap, in a cash and stock deal1.

As a result, all former TSLA stock holders receive 4x their holdings in TSLA as shares shares of AAPL. The TSLA investors get at least a 400% return and now receive a 1.5% dividend from a reasonable priced technology company with a fast growing services business.

Now your upside is essentially unlimited.

This is an extreme example, but it could be used with any stock with a dividend.

Compare this result with the short seller’s bet where you can only earn 100% on your money and you can see why making long term positive bets has greater potential for profit.

Footnotes

  1. Apple has more than enough cash and stock to do so