There’s been a lot of discussion recently about the volatility of share prices from short-selling stocks. This has impacted the prices of stocks including GameStop, AMC, BlackBerry, and others. Engaging in short-selling of stocks is possible for a retail investor like myself to do. However, it carries more risk than buying (or being long) a stock. It’s also more of a short-term play, whereas I prefer to buy-and-hold for the longer term.
What’s involved in short-selling a stock?
Investors short-sell a stock when they think the price will fall. I’ve sometimes pointed out when I think a stock is overvalued, such as with the Ocado share price late last year. If I wanted to act on this idea, I could hit ‘sell’ on my trading account instead of ‘buy’. Even though I don’t own Ocado stock, it would allow me to short sell it, and thus benefit if the price moved lower. I’d need a leveraged or margin account to do this, and in some cases this would involve borrowing money from my broker.
The main reason why short-selling a stock is riskier than buying is due to the potential loss size. When I buy a stock, the most I can lose is 100%. The share price cannot fall below zero. If I short a stock, my potential loss is unlimited. The share price could go to infinity, meaning my loss could be greater than 100% of my funds.
Short-selling can be helpful as a risk management tool, to protect me if I’m holding a stock and it keeps falling in value. Also, short-selling a stock by itself can be very profitable if I time it correctly. But it’s mostly done by institutions, with risk managers watching the trading position. If I shorted a stock, I’d struggle to accurately gauge the risk I was taking on.
My buy-and-hold strategy
Instead of short selling stocks, I’ve been more profitable buying instead. Recent moves have shown that buying stocks with high volatility can also be risky. For example, the GameStop share price dropped 70% last Thursday in the space of only a few hours. It can be argued that this is an isolated example. Even so, I prefer to stick closer to home, investing in FTSE 100 stocks that have been listed for many years.
This buy-and-hold strategy can yield strong results over time. I recently wrote a piece talking about Anglo-American. Over a five year period through to the start of 2021, the share price rose 813%. During this period, there were days when the stock fell. But over the longer-term, the trend was moving higher. I do need to be careful though, as this was the top performer. Other stocks may not rise in value even over a long period.
Emotions can easily cloud my judgement in the short-term. If I saw a stock fall 70% in a day and then rally 100% the next I’d have a headache and need a large beer! It’s so hard to make rational calls when looking to benefit from short-term moves. Short-selling a stock only compounds this, due to the constant worry of carrying unlimited liability if the share price moves higher. So I’ll be sticking to going long stocks, and doing so with a long time horizon.
