Don't Just Blame the Shorts for Pulling the Market Down

• Email
• Share
• Print

Right off the bat, I should let you know that I never sell stocks short, and probably never will. However, the fact that so many people vilify short-sellers strikes me as naive and short-sighted.

Beyond the fact that it's psychologically challenging to bet against a stock (and that's probably where the villainous, moustache-twirling, dark-cape-wearing stereotype of a short-seller comes in), I've got two opinions on the subject:

• I'm terrified of short-selling, and would never do it. Even if you're not "wrong," just poorly timed, you can lose your shirt. Plus, your losses can be much more devastating than a long position gone wrong. (Short squeezes can't be fun, either!)
• Even though I think short-selling is a risky practice, in the long run, the fact that short-sellers exist is good for an efficient marketplace.

But there's an awful lot of buzz these days, a tendency to blame the shorts when stocks go down. Shorts do profit when the stocks they've chosen go down in price.

Indulge your inner short-seller
Our community-intelligence database, Motley Fool CAPS, can give a good feel for just how damaging a poor or ill-timed short sale can be. A couple of years ago, I was not alone here at the Fool in thinking Crocs (Nasdaq: CROX) was overpriced, even ridiculously so. CAPS allowed me to simulate "shorting" the stock by putting an "underperform" call on it in November 2006.

At one point, I was 200 points in the hole with that call. The story has a happy ending (for my CAPS score anyway); I took my lumps for ages, and ended my pick this past February, when I had a score of positive nine points on my Crocs "underperform." (True, it's not much of a gain, but it is a dramatic reversal.)

Of course, I've got some other rather calamitous CAPS "shorts" right now, such as my brilliant "underperform" on Monsanto (NYSE: MON), a company I've never been too fond of given some practices I find controversial. Of course, what I didn't see coming was the corn boom -- my Monsanto score is currently down 163 points. Ouch. (I'm happy to say, though, that despite that bad call and a few others, as of this writing, I'm still holding on to CAPS All-Star status.)

You're just short -- not that there's anything wrong with that
It would be hard these days to admit in polite company that you've sold a stock short. This morning on CNBC, I even saw Jim Cramer railing about short-sellers plotting against financial stocks like Lehman Brothers (NYSE: LEH) and Merrill Lynch (NYSE: MER). Come on, though, aren't there plenty of good reasons why people might be worried about those companies' problems?

Along related lines, I saw a Reuters article yesterday where a spokesperson for Lehman commented about the stock's drop, and this quote shocked me: "There are a lot of rumors in the marketplace that are totally unfounded. We are suspicious that the rumors are being promulgated by short-sellers of our stock that have an economic self-interest."

Isn't "economic self-interest" what all of us have, if we have any interest in stocks at all? It's not like there are never positive (and just as unfounded) rumors that float around, occasionally sending stocks skyward for no real reason.

Here's an oldie but a goodie from 2004: The rumor went around that TiVo (Nasdaq: TIVO) and Netflix (Nasdaq: NFLX) would hook up to bring downloaded movies through the TiVo box. At the time, an anonymous source said it was "all but a done deal," yet here we are, and that long-rumored event never came to pass.

Earplugs are for rock concerts, not investing
Blaming "the shorts" seems to be an increasingly popular pastime. I guess it's partly human nature to dislike negativity, especially when it relates to your finances, but investing really does require fighting against certain psychological pitfalls -- like the urge to plug your ears to bad news or risks, for example. I believe every investor should strive to carefully weigh not only the positives of their stocks, but the negatives, too. Being blind to bearish opinions -- or worse, outraged by them -- is a terrible way to run your portfolio.

And of course, without short-selling, stock prices would reflect only optimism. Does that sound rational to you? We might not like to hear what the bears have to say, but good or bad, it's all information, and it's a mistake to ignore it out of hand. (My previous example about CAPS is a great example of polling such sentiment, both positive and negative.)

I think it's better to examine all the data you can get your hands on and figure out where you stand on stocks. If you're invested in solid, well-run companies, you've calmly and rationally assessed the risks, and you're prepared to stick around for the long term, then I'm betting you have little to fear from short-sellers' alleged villainy.

For more on short-selling, see the following articles:

• One Fool explained why short-selling will short-change you.
• Another Fool warned not to sell short-sellers short.