When new investors begin to learn stock market tips they often become fascinated with the idea of short selling. The ability to make money in both an up and down market makes many green investors feel they can’t lose. There are some added complications that come with short selling. There are many traders and investors who do well with short selling, but the added risk should be clearly stated before someone adds it to their investment strategy.
The first added risk comes from borrowing money. When you short sell you sell a stock you don’t own in order to get the money from the sale. You owe that money back in the form of buying the stock at a later date. Obviously the hope is that the stock will be down in price when you buy it back, but if it starts to head in the wrong direction you can be forced to buy the stock at a higher price similar to a margin call.
Infinite Risk
When you purchase a regular stock for a buy and hold investment the worse that can happen is the stock can go to zero. Obviously that’s bad, but not as bad as a penny stock that goes up 200% overnight on incredible earnings and you now have not only lost all the money you got from the short sale, but you owe that much again. A stock can go up forever, but can only fall to zero.
Fighting the Flow
The whole history of the US stock market shows stock prices climbing. Increased earnings, productivity, and inflation all push the prices of stocks upward at a rate of about 8% per year. So when you are choosing stocks to short sell you are fighting a trend. This upward pressure is increased risk in an investment that might be right, but ends up staying flat for years and then starts to climb again. You still lose in this situation.
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