Saturday, June 9, 2007

To short or not to short that is the question

I'm going to talk just a bit about shorting today. Once an investor becomes experienced enough the question or should I say the temptation to short will come up. Shorting can be a very valuable tool. It allows an investor to profit when markets are falling and make money when everyone around you is losing theirs. However there are pitfalls to consider when shorting. The 2 biggest of course revolve around the fact that the most you can win by shorting is 100%. So if you score a home run and the company goes bankrupt you double your money. The bigger downside is that the risk is infinite. Stocks can go to the moon. In your favor, markets fall faster than they go up so you see the gains much quicker if your short call is correct. Lets take a look a PCU. Lets say you think this company is a dog so you short it. Maybe it is a dog. But for you to even make 50% this stock is going to have to really fall apart. This just doesn't happen that often to good companies. Some kind of sea change would have to occur for a company like this to lose 50% of its value. For it to go bankrupt and go to $0 would take some time don't you think?
However it only took this outstanding copper miner 5 months to double in price. So you tell me is it better to take the risk and short for a 10 to 20% profit or just have a little patience and hold on for the big money? There's a reason most traders don't short and it's not because they don't know how. It's because the returns don't necessarily match the risk. That being said I definitely do take short trades but I want the "Boys" in the COT shorting with me before I do it.