Market-players can spend long and happy lives without shorting a stock — and according to some experts, that’s just what they’d better do.
Short-sellers borrow shares from a broker, believing that the stock’s price will fall. The shares are sold and the proceeds go into your account. At some point you must cover the short sale, by buying the same number of shares and returning them to the broker. If the stock price falls, bingo! You buy at the lower price, repay the broker, and pocket a profit.
If the price goes up, welcome to the loss column.
That’s why hedge fund manager William Fleckenstein, of Fleckenstein Capital, says shorting is best left to the pros. “It’s more difficult than most people think,” he says. “You need a business that seems radically mispriced vis-à-vis the underlying business prospects.” And so-called common sense isn’t enough.
“The worst reason to short is high price alone,” Fleckenstein says. “For a long time everyone wanted to short Krispy Kreme. They said, ‘How can a donut shop be worth all this money?’ And the price just kept going up and up.”
David Johnson, a Dallas-based business analyst and commentator for Public Radio’s “Marketplace,” isn’t quite as leery of shorting. “Sure, if I short a stock at $30, my loss potential is infinite. The stock could go to $500. Still, if you’ve got some insight, or you see that all the competitors in telecom are going to beat each other’s brains out, shorting is a reasonable thing to do.
“But just remember the old adage: ‘He who sells what isn’t his’n must buy it back or go to pris’n.’”