Expert: Christopher Worsh - 11/8/2001

Question
Dear Mr. Worsh,
    I was wondering if you could clear up a few things about short selling for me.

First, why does everyone say that it is so "risky"? I understand that it is possible to loose more money than you put it, but wouldn't the stock have to go up more than 100% for that to happen? (An unlikely scenario for short term traders)

Also, I understand the margin rate charged on each trade when shorting is +/- broker's call. Well I found one quote of it to be around 6 percent. Does that mean that every trade has to make more than around 6 percent gain to be profitable? If so, how do day traders make small percentage profits shorting stocks?

Finally, do you know an online site where I can find the broker's call?    

Thank you for your time.

Nick

Answer

Nick,

>First, why does everyone say that it is so "risky"?

You've got it. Shorts like any trade that you initiate, are only as risky as you allow them to be. As long as you apply proper risk management to your trades, you will always be prepared for the risks involved. Most of the "noise" concerning the added risks of shorting stocks seems to center around the fact that stocks inherently have unlimited growth potential and therefore unlimited upside trading potential. This coupled with  the fact that they have a limited downside potential leads some to proclaim that shorts are therefore "riskier" than longs. This is only true when a proper stop loss is not in place and is not executed once triggered. In truth, the only significant risk in the process of shorting (for short term traders with good risk control)is falling victim to the amateur view that it is too risky and should be avoided. Now that is a risky trading position because you rob yourself of all the potential profits that can be made from "fear" within the markets. More than 50% of my profits are made on short sales.

>Does that mean that every trade has to make more than around 6 percent gain to be profitable?

No. The 6% you are referring to is simply the margin interest that you will be charged on an Annual basis because you are borrowing a stock and selling it. So divide the rate by 365 to figure out the daily rate you will be charged. Brokers do not pay interest on the funds from the short sale and the funds will not be swept (as they are normally)into the customary money-market account where they would gain interest. If you wanted to and were able to hold your short for years, then yes, you would be charged the 6% rate every year.

>Finally, do you know an online site where I can find the broker's call?

I would just ask your broker. I don't know of any Site, but it's set by the bank that your Brokerage borrows money from.

                     Take care,
                  Christopher Worsh