In 1986, famed economist Gary Shilling coined the above quote in explaining why he was changing his investment strategy despite his belief that the strategy was correct. I bring up this quote, not in relation to the current market situation, but instead to highlight the dangers of shorting a security.
When you are “short” a security, you are actually selling the security at the current market price before buying it. In this situation if the security rises in price, your investment is losing money as you will need to purchase the security at a higher price than where you already sold it. Of course if you did “call the top” and the security plummets, you can make up to 100% of your investment (if the stock goes all the way to zero), but that is the full extent of your gain. Conversely if the security continues to rise, you can lose an infinite amount of money, because there is no cap on the value of an investment.
The best example is GameStop. GameStop is a company that sells new and used video games. With the move to digital downloading of video games directly from publishers to consumers, GameStop’s business model (and future) looks bleak. That attracted a lot of short-sellers (people who short securities) to short GameStop’s stock. Initially, the short-sellers made a lot of money as the stock went from an all-time high of $60 a share to less than $5 a share. But then a group of investors got together and placed a lot of buying pressure on GameStop’s stock. As the stock price rose, the short-sellers were forced to buy back their shares that were sold short (due to heavy losses exacerbated by out-sized and leveraged positions), placing additional upward momentum on the stock. This “short squeeze” pushed the price of GameStop’s stock from $18 to $483 in less than a month! In this example, if you had sold short 100 shares of GameStop at $18 a share (an $1800 investment that at best can earn you $1800 if GameStop stock goes to zero) you would’ve lost $46,500!
So while shorting a stock may look like a “No-Brainer,” markets can remain irrational a lot longer than you and I can remain solvent.