Is Short Selling Worth the Risk?

For most investors, buying and holding a stock is extremely intuitive.

When you go long, you are betting on that particular company’s success. You are hoping that the market values the stock higher in the future than they do today. Then, when you sell your stake in the company, you’ll realize those gains for a profit.

What is less intuitive is the practice of short selling – or betting against a specific stock or security. While the concept may seem simple at first glance, the actual mechanics behind it are much more complicated for an entry-level investor to understand.

Further, short selling has all kinds of intrinsic risks and costs that need to be understood before it should be used as a tactic. Not grasping these risks can lead to all kinds of horror stories.

Is Short Selling Stocks Worth It?

Today’s infographic comes from StocksToTrade.com, and it addresses the question of whether the risk of short selling is worth the potential payoff.

Our thoughts? Short selling is a tactic used by intermediate to advanced traders, and it should only be attempted by someone who understands the mechanics and risks behind it. Under those circumstances, it can be a useful way to hedge or to profit in a down market.

Is short selling worth it? It likely depends on your level of sophistication and risk tolerance.

The Risks of Short Selling

Here are the specific risks of short selling that every investor should be aware of:

• Losses can keep mounting. The maximum profit you can make is capped at 100% – but if a stock keeps increasing in price, losses can accumulate far beyond that.
• Additional costs. Short selling has a different set of costs than simply buying a stock. These include margin interest, stock borrowing costs, and dividends.
• Short squeezes and other events. Stocks with high demand for shorting can have a “short squeeze” – an event that forces short sellers to close out their short positions. This can add even more upward pressure on the stock.
• Timing is crucial. Over time, generally markets have moved upwards. Even if your short play is a good idea, the market could continue to carry the stock in the interim.

Got a shorting success or horror story? Feel free to share it in the comments below.