Sometimes the Best Short Is Simply Not Being Long

Having an ego can be dangerous when investing.

We all have difficulty admitting we are wrong in every walk of life, and it is no different when it comes to the markets.

A steadfast opinion can crimp overall returns. This is especially true when it comes to short positions.

Most people shouldn't short a stock. There, I said it.

I have done it before with mixed results, but it hardly seems worth the hassle. For every hedge fund manager like Jim Chanos, there are 100 others who should never do it.

Just do a web search on "how I lost money shorting stocks" and shorting drawbacks will become immediately apparent. I suspect that those who are reading this aren't running hedge funds, so no need to pretend to satisfy some sort of animal spirit.

I don't have a problem admitting that Chanos and others like him are smarter than I am. Join me in the realization that "not long" is many times the best position in a stock viewed as overvalued.

That advice is a bit uncommon for good reason.

Brokers want commissions. Short positions inherently cause more trading, which leads to more revenue for the broker.

Folks who are selling subscription or other services like to tout short ideas because it can give credence to the service if the short plays out. Meanwhile, some don't even short the idea that they are touting.

The only free lunch in investing is collecting fees, commissions or subscription revenue. My hat is off to all who manage to do this.

Some "eat what they cook" and provide solid advice for a reasonable cost. Others don't.

I have met plenty of affluent people over the years, including parents of college classmates, pro athletes, real estate investors, etc.

I have never heard one of them say, "Boy, I made a ton of money shorting (blank) stock. It really set up me for the wealth I've built today."

Not once.

That isn't to say that investors can't still benefit from a short analysis or a short bias on a stock. Sidestepping land mines can be very beneficial when it comes to overall returns.

LinkedIn proved to be fairly resilient for quite some time. A person could have driven themselves crazy shorting it based on the fact that no one really seems to enjoy using the service and that the value of the company was more than $30 billion at one point.

One day it can go "boom," but it can be a long and arduous process to do it.

One day, an investor's instincts can be proven correct. Waiting for that day can be costly, though.

Buy puts? Let me introduce time decay.

A put spread? Here is how to pay to cap gains.

Probably the "safest' strategy is to short the common of an issue an investor doesn't like and buy a call above the current value, which protects the investor from a loss beyond that strike.

Here again though, the investor is paying for that protection, limiting gains, and it isn't indefinite, meaning that the investor might have to buy the protection while the short "plays out," if it ever does.

"I'll just put a stop loss in, no problem."

If I can be guaranteed that there won't be a "flash" incident in the market, that could work, but I wouldn't count on it.

For all the talk of flash crashes, even flash rallies, there is rarely talk about flash crashes or spikes in individual stocks. They aren't all that uncommon.

I haven't even mentioned how a stock can only go to 0 but can, theoretically, rise forever. That isn't a recipe for a good night's sleep.

For those who can find a short that already doesn't have a high interest and watch it closely, it can go well, but how often will that happen?

A large blue-chip company isn't going to run away from an investor who is short, but how much money is there to really be gained there? Is it really worth the time and effort?

The fancy Wall Street parlance for this is "opportunity cost," by the way.

I have had some luck over the past few years shorting and buying puts on IBM as have many people, but it isn't close to outperforming any of my longs. Did my focus on IBM keep me from finding another long that would have outperformed my IBM short?

Maybe a company that has been taking from IBM over the past few years would have been a better long as opposed to being short IBM? I suspect that the answer is yes.

If the average person can be pushed to cash in a 401(k) by a string of bad headlines, it isn't going to take long to cover for a loss on one headline that works against you on an individual short.

How convicted can you be after all? Just don't be long.

You aren't selling anything or trying to ink a book deal. You are investing for retirement, a vacation or a college education for your kids, so there is no need to be a hero.

Avoid stocks that appear overpriced and look for longs that play into that thesis.

Remember that these hedge funds that have elaborate short positions using options and stock have an advantage that average investors don't: They aren't using their own money.

If you all want to give me a couple of hundred million dollars, I can find a long list of stocks to short and then just shrug my shoulders, collect my 2% and go about my day if they don't work out. I am happy to do it, but I won't hold my breath.

As is the case often in investing, doing nothing is probably the best option. Investors shouldn't rob themselves of other gains in their portfolios to finance short ideas that are probably doing nothing more than soothing their egos.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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