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Here's Why Shorting a Stock Can Be So Dangerous

By Matthew Frankel, CFP® - Feb 17, 2021 at 7:38AM

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Most investors should generally avoid shorting -- and for good reason.

The short squeeze phenomenon that affected stocks like GameStop (NYSE: GME) in recent weeks really serves to emphasize why shorting is such a dangerous practice. And not just for the hedge funds that lost billions -- it can be devastating to retail investors as well when short selling goes wrong. In this Fool Live video clip, recorded on Feb. 8, contributor Matt Frankel, CFP, and Industry Focus host Jason Moser discuss why shorting should generally be avoided by investors, no matter how expensive stocks look. 

Jason Moser: What you've got to be really careful of in many cases, particularly with these companies where they have really high short interest, you'll see that metric days to cover. That's essentially based on average volumes how many days of that buying activity is going to take to actually get all of that short interest cover, so then you can kind of start to quantify how long that pain might last if you're short. [laughs] For me personally, folks have asked me before, I mean, just as an individual investor, to me, shorting just seems like a lot of work for really not a lot of reward. I mean, I like to say the juice just isn't worth the squeeze. Because in theory, the most you can make is 100% on your investment. You can lose -- essentially then the loss could, in theory, not stop until you close that short out. I mean, you could lose well over 100% of your money. So, for me, it just seem like an awful lot of work for not a lot of return, and that's why I never bothered with it. I don't think I ever will bother with it. I'm not sure how you approach shorting, if you see it the same way, or if you make shorting a part of your investment strategy.

Matt Frankel: I have never directly shorted a stock. I've used options positions to bet against a stock continuing to go up.

Moser: Yeah.

Frankel: The reason options are so much better is like you said, when you short a stock, your loss potential is unlimited. Options really limit your losses. The most you can lose is the cost to the option.

Moser: Yeah. You buy a put contract, you know what you paid for, and then that's that. If it works, great. If not, you know what you're risking.

Frankel: Right. So I've done that, but I've never actually shorted. But a lot of people do.

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