5 Reasons Why I Don’t Short-Sell Stocks

Most rideshare drivers probably have a checking account. Many might also have a separate savings account too, possibly with a high interest rate. Even fewer drivers are likely to have a retirement account setup, which would need to be done independently (since no rideshare-app companies currently offer 401Ks). And if you’re a rideshare driver that’s currently investing some of your profits into a brokerage account, it’s far more likely that you’re purchasing Exchange Traded Funds (ETFs) or Mutual funds.

These characteristics described are exactly what my financial picture looks like right now. I’m using a business checking account, a linked high-yield savings account, am socking money away into a brokerage account, and have an Individual Retirement Account (IRA). What I don’t do with my rainy day money is buy/sell individual stocks. And especially don’t short-sell stocks through a trading platform of any kind. Here’s why.

5 Reasons Not to Short Stocks

If you’re unfamiliar with what short-selling, or “shorting,”  stocks is, it’s basically making money on the drop of a certain stock’s value.  This is accomplished by borrowing the shares from a particular broker, and selling them at their present value, immediately pocketing the cash.  Then, after some time passes (and presumably the stock-price has dropped as predicted), you “cover your short” by buying an equal amount of shares that were borrowed (now at a lower price, earning you a profit), thus returning them to the broker.

Check out this article for a more in-depth description of the process.  And/or watch the following video:

 

1.  Too Risky

A successful short-selling would only occur if the value of the shares borrowed decreased, when you decide to cover your position.  This isn’t a guarantee, and conversely if the stocks’ value were to increase instead you’ll be out money.  As discussed in the included video.  Even if you put a stop-order in, which means the brokerage will automatically cover your position if the stock price hits a specific value, there’s no guarantee that the daily fluctuations (of the market in general) will go down (which the short-seller is hoping for).

And if they do go down, then you cover your position, there’s no guarantee that it (i.e., the individual stock value) won’t continue going down afterwards.  That means it’s very difficult to estimate when exactly to cover the position; because stock-value fluctuations are by definition the opposite of static.  To illustrate this point, here’s an example from my Investopedia Simulator.

I tried short-selling Buffalo Wild Wings (BWLD) in the stock simulator, borrowing 100 shares to sell at $160/share back in February.  The total value was $15,980.01 after a $19.99 commission.  Nine days later, the price of stock dropped to $156.75/share, and I felt like it was time to cover my position.

 

The cost of covering 100 shares at this price was $15,694.99 plus, again a $19.99 commission.  Therefore my profit on the exchange was:

$15,980.01 –  $15,714.98 = $265.03

Okay, so probably not worth the effort?  Plus once the price started falling, I got super excited/anxious and couldn’t get it out of my head to cover my position to avoid risk; however, if I had held onto this position until TODAY I could’ve covered at a much lower stock price.

As you can see BWLD is now trading at $117.55/share!  Who has that kind of foresight? Definitely not me.  Along these lines, the 52 week range (circled in red) gives a clue as to how far down these share-prices have come.

$15,980.01 –  $11,774.99 = $4205.02

Which means I covered way too early, and left a lot of money on the table. I’m just not experienced enough to be allocating ANY assets towards this investing strategy (which I’ll discuss more later).

2.  Too Costly

So I’ve covered the risk portion of short-selling.  But you might be thinking that the BWLD trade illustrated above is good example of why you SHOULD get into the shorting business.

“I’ll learn how to spot good investments from an online trading course.  The professionals will gimme a nudge when it’s time to buy/sell.”

Okay, but have you considered that every individual stock transaction (e.g., buying, selling, covering shorts, etc.) comes with a commission fee?  It’s true that in today’s competitive market fees are down under 10 bucks per transaction for some online brokerages; but, as everyone in the personal finance world knows, recurring fees are the enemy of wealth.  Suppose you are successful in you first trade, even making a couple hundred bucks as I did.  Now you might ramp it up to several trades per month, even per week perhaps.  Those fees will accumulate very quickly, and rapidly eclipse the cost of buying & holding in an ETF.

Furthermore, learning how to trade on a specific platform alongside professionals (e.g., with an online trading school) often carries a price tag of tens of thousands of dollars for the more advanced courses.  Don’t let them reel you in.

3.  No Dividends

Short-selling is a one-time bang for you buck, which some traders may prefer.  Another issue with this strategy is the opportunity cost of tying up your cash in a ghost asset.  When I buy ETFs through my brokerage account, I’m literally purchasing a share of the companies included in that stock.  Therefore, every month when dividends are issued out by the companies, I get a little piece of that action.  This is the secret to compounding interest; because these dividends are reinvested right back into my portfolio like clockwork.  Which means I have MORE shares to my name for next month, when the process gets repeated.  Some people have investments so big, they’re able to live-off (a portion) of their portfolios’ returns every month.  I’m not there yet.  But I’m on the right track.

4.  Lack of Liquidity

This argument can be made against the buy & hold bulls of the world.  Because we aren’t touching our money-piles, but instead letting them appreciate.  The problem with shorting stocks, as I see it, is there could be a comparable amount of waiting before you decide to cover your position.  Referring back to the BWLD example, the stock’s value took a full nine months to drop low enough to consider covering.  If instead of using the ~$16k to short-sell BWLD had purchased an equivalent amount of Vanguard’s Total Stock Market index fund (VTI), how would it compare?

Over the same time period, the stock-value of VTI has appreciated by 13.84%.  Meaning my ~$16k would now be worth ~$18,211.63, or have appreciated by $2,211.63.  And I would still own the stock, and be getting paid dividends all along.  So I guess the argument here is that if you’re going to tie-up your money in the markets, buy something that you’ll own at the end of the day.  Remember……   dividends!

5.  Lack of Investing Experience

Finally, my last point of contention with shorting stocks is that I just don’t have the experience.  For many, many people, the buy & hold strategy is a simply a lazy but effective way to put your money to work.  Plus it’s a snap to get started in today’s world of robo-investors, smartphone apps, and the like.  I’m the furthest thing from a financial expert, which is why I don’t like to get fancy when it comes to investing.

According to Joshua Kennon of ‘The Balance’ blog, investors who are inexperienced have no business in more advanced trading techniques like shorting stocks.  As the potential for loss is unlimited if you make the wrong bet.   Another interesting aspect of shorting from that article is that the borrower is responsible for making dividend loss payments to the broker.  Because the broker won’t be receiving regular dividends until you cover your position, and buy-back the shorted shares.  If you’re STILL not convinced that shorting is a bad idea, read this case study about how one investor went into over $100k in debt in a matter of minutes by shorting stocks.


Feature image courtesy of the aformentioned The Balance blog, “Short Selling Definition – An Explanation of Shorting Stocks,” retrieved from: https://www.thebalance.com/short-selling-definition-short-a-stock-357792

What’s your investment strategy?  Would you ever consider shorting stocks?  Have you ever received dividends?