Tuesday, April 10, 2007

Why I'm Short on Short Selling

I'm not a big fan of selling a stock short. This is mostly because I try to invest more long term than short. In the long run, there are too many things stacked against you. The general trend of the stock market is up, so unless you have reason to believe a company is going in the tank, you can't short a stock for very long.

Shorting is dangerous, but not for reasons you may think. Stocks do indeed go down quicker than they go up (look at Feb 27 for example), but you have the danger of the short squeeze. When a rumor flies, or a stock is upgraded, often times the people shorting the stock all rush to cover. This along can really drive a stock up, especially if it is large hedge funds doing the covering.

I also am against shorting because you are limited in what you can make. A stock can only go as low as zero, and the odds of that happening are very low. But there is no limit on how high a stock can go. If you go in long on a great company, you can often make well over 100%. That opportunity simply doesn't exist when selling short.

In conclusion, I must say that there is a time and place for selling short. Large money managers have a good use for it to hedge their bets in case of a market downturn. But to the average investor, you are much better off building a well-balanced portfolio on the long side of stocks with great future earnings prospects.

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