Short Selling Isn’t Dead, You’re Just Doing It Wrong

“Short sellers are the market’s police officers. If short selling were to go away, the market would levitate even more than it currently does.” – Seth Klarman

Seth Klarman’s positive take stands in stark contrast to the current zeitgeist…

So are we seeing the end of short selling? The answer is a definitive no. It’s just out of fashion now, which reflects where we are in the cycle than anything else. And that’s typically the time when one wants to start looking for short opportunities.

But shorting is a different animal. It’s a Pandora’s Box of risk, emotional stress, and the constant fear that your short will issue an after-hours PR and explode into new all-time highs.

It’s not enough to find an overvalued stock or a blatant fraud. A proper shorting strategy requires tools and methods that are foreign to most long-only value investors.

This essay exposes the three common traps investors fall into when shorting stocks. Then, we invert these misconceptions to reveal a proper, bullet-proof shorting strategy. One that will help you navigate the steep decline in EV pumps, $100M+ delis, and anything Chamath throws your way.

Short selling isn’t dead; you’re just doing it wrong.

Three Common Traps Investors Fall Into Short Selling

Trap 1: Shorting creates the potential for “infinite losses.”

On the surface, the statement is true. There is no upper bound to how high a stock can trade. But that’s only true if you don’t use proper risk management.

To avoid using mechanical stop-losses, investors undersize their short positions, often maxing out around 25bps of total capital. Even if you’re right on the short, a position size that small barely moves the needle.

Trap 2: Shorting only on fundamental data

Shorting on fundamental data kills more investors than a falling hardcopy edition of Intelligent Investor. In the short term, the market is a voting machine, and voters don’t care about fundamentals. They care about emotion, passion, and the desire to help change the world.

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Disclaimer: All statements are solely opinions and are for educational purposes only.

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