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A Short Story
Despite having been friendly with many short sellers, I had never actually shorted a stock myself.
I wanted this to change.
2022 had been such down year and there were plenty of actionable short ideas. My curiosity needed quenching.
Some people are against short selling (betting a stock will go down)— which I can respect. They see it as 'profiting off of failure.'
However, short sellers keep the market honest. They offer a counter-balance to euphoria— providing a mechanism for unchecked bullish mayhem.
And if a short is wrong, you can lose MORE than 100% of your money.
Seems like a short seller will lose his shirt long before you need to shame him.
But be warned, you who thinks of short selling— there are risks abound. Do not try this unless you understand what you are doing. Even if you understand, shorting is not a tool that most people should be using.
So with the risks in mind, I scanned the horizon for a short opportunity to jump out at me.
One did on November 29th, 2022.
China had announced the end of Covid-lock downs and many Chinese stocks were pumping.
In particular, $NIO the Chinese electric car manufacturer, was up 5% on the day because of the news.
I knew:
- Nio was losing money, and only had enough cash to survive a couple more years
- Gross profit margin was decreasing
- The delivery forecast in Nov. 2022 was the best piece of news that had come out in a while from Nio. But I didn't trust that they could hit their numbers.
So I borrowed the stock and sold it for $10.56 a share.
What happened next?
$NIO proceeded to go UP 30%, as the market got even MORE excited about the end of Covid lockdowns.
Since this was a speculative trade, it probably would have been wise to have a mental stop-loss. Say, sell when the stock moves 10% against me. But nothing had changed other than the news about China. Once the news died down, shouldn't this stock come back down too?
Yes. It did.
The news blew over, Nio revised their delivery estimates down and the stock plummeted.
It was a wild ride, but today Nio closed 17% lower than when I shorted it.
So I bought the stock at $8.72 (which was 17% less than when I sold them for $10.56 in November) and returned the shares I had borrowed, keeping the 17% spread.
Lessons learned
- Things can immediately go bad to begin with. This doesn't mean your busted, but the risk is elevated immediately. Shorting isn't low stress.
- Accept delays in your thesis, but only to a certain point.
- Shorting is a tool. It's not good or bad, just something you can use in certain situations. These situations often tend to be more speculative in nature.
Have you ever shorted a stock? What happened?
Are you looking at shorting anything now?
with shorting the number one thing to watch out for is risk control. Without it you can be right regarding a stock but go bust because you didn't manage risk properly. I think it's also not appropriate for 90% of investors.
@rihardjarc 100% agree— shorting has more risk and its not good for most people.
@rihardjarc I think 90% is an understatement. I’d put it at 98%.
@interrobangbros You are right.
@nathanworden But I agree with you Nathan it is an important instrument for keeping the markets "in check".
@rihardjarc Can you share more about what you mean by 'being right but not managing risk properly'? I think an example would help a lot.
Another risk to be aware of is that some brokers will charge you a fee for borrowing shares, so you lose money over time. Vanguard didn't do this to me, but when I looked into shorting on Robinhood, the fee was like 8%
@interrobangbros I think you're right— shorting is not right for the vast majority of people.
@nathanworden A good example is maybe Melvin Capital's Gabe Plotkin. Super smart guy one of the smartest on Wall Street, he was right that the stock prices of these meme stocks ($GME, $AMC...) were bizzare but in the end this short trade costed him his entire firm and fund to close, because he underestimated how high the bizzare price can go. As you said shorting opens you up to losses of bigger than what you invested and that is why you need to have stop losses and other risk measures in place and sizing it right otherwise you can lose a ton of money even tho the stock is lower 6 months later and your "thesis" was right.
@nathanworden Wild roller coaster ...
@kostofff Indeed it was!
@rihardjarc Ah got it— that's a great example. So essentially, when you short a stock, you might be "right" that six months later the stock is lower, but three months in, if it goes so high you are forced to cover your short, you still lose. aka "you can be right but still go bust."
Really great point for people to consider first before trying to short.
@nathanworden You have to watch the recent Daily Journal $DJCO Annual Meeting. Charlie Munger touches on his experience regarding shorting stocks.
“I don't short. I have made three short sales in my entire life, and they're all more than 30 years ago. And one was a currency, and there were two stock trades. In the two stock trades, I made a big profit on one and made a big loss on the other, and they canceled out. And in my currency bet I made a million dollars, but it was a very irritating way to make a million dollars. I've stopped.”
@kostofff Good ol' Charlie— does that mean I get to make two more short trades before I cut myself off? 😄
@kostofff I believe this is the Daily Journal Annual Meeting you were talking about? (I jumped to a random part and Charlie Munger was eating a cookie, so I'm already loving it 😄)
@nathanworden I'm pretty sure he's eating peanut brittle from See's!
@nathanworden Who knows ... 🙂
@tomato Exactly.
I have shorted stocks in the past (20 years ago).
I don't short stocks because the asymmetry falls on the risk side of the equation.
You engineer return asymmetry via a stop-loss, but you can be in a world of hurt if the stock price gaps over your stop loss and your trading platform doesn't offer guaranteed stops.
There's also a timing risk, you can be right on the direction, but it might not happen for some time. If the stock you're shorting pays dividends, you'll be up for that payment if you're still holding a short position on dividend pay date.
However .... putting my trading cap on, I never pass up an opportunity for a clear profit if I really think it's a sure thing (happens every one in a long while).
If I want to short a stock, I'll buy an option put on the CBOE. Usually nothing less than 6 month expiry, I want to give the trade plenty of breathing space because I always get the timing wrong. That way, I know exactly how much money I'm risking. An option can only go to zero. You pay an option premium up front, so you have to do your calculations on the "effective interest rate" you're paying for that option. But you know exactly what your maximum risk is and you are pay it up front.
Using put options as a means to short a stock is more expensive than placing a short equity trade, but it is safer and it passes my sleep test.
(Payoff chart when you short a stock)
@jazziyoung great point about being up for a dividend payment if the stock you’re shorting pays them.
And great chart too!
Wonderful post ! The EV space has plenty of price volatility indeed. Are you shorting something else now? Or have you retired from shorting ?
@consumeowntech I am not currently shorting anything at the moment, I would say I'm cautiously looking for more shorting opportunities— but as evidenced elsewhere in this thread, its not to be taken lightly. So I'm not trying to rush into anything. That being said— if you have any short ideas, I love talking about them :)
Great ride. Personally, we do not short but rather avoid stocks that we believe are overpriced. As @rihardjarc said this is not for everyone and it is a risky trade, especially for retail investors. But your observation that short sellers counter-balance euphoria also makes sense.
Did you get any margin call when the price increased by 30%? If yes, it will be good to share the lessons learned at that time and how you felt about it.
@stockopine great question— no I didn’t get a margin call because I had many multiples of cash in the account in excess of the size of the the short position.
But that is a fantastic point, and something I should have mentioned in the post: Another risk to be aware of when shorting is margin calls. Since you are borrowing shares, this is a form of leverage and your broker will have rules around how much a position can move against you before they require you to add liquidity to your account :)
@nathanworden exactly. Just wanted to make sure that everyone who reads the post gets to understand the risks. Because even if you get it right that the stock will drop, it might take time for that to happen. If there are no sufficient funds the position will close and one can lose money despite being right.
Glad you got to check it off your list. Curious to know how you plan to incorporate this tactic in your long term strategy.
@talldata I would say that it’s a tool I want to be able to use in specific situations, but not something I want to do regularly.
I don’t want to never short, but I also don’t want to short often.
I’d say going forward, I’d expect to use shorting 5% of the time or less when looking at opportunities.
Hopefully that’s helpful!
@talldata great question!
2022 is a year where shorting is a much better way to still get profits fr the market. If i didn't look for counters to short i could not get profits to add to my long counters. Short are good for shortterm trading.
@kckc Yes, exactly, there's a time and a place. 2022 was one of those times.
Not comfortable with concavity of shorting.
At most I would buy puts, but not a fan.
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