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  • Writer's pictureMatt DeLong

Why would you short sell when you will have to pay interest on it rather than long with no interest?

Even though shorting typically costs “borrow fees”, the costs/risks are higher too. FEAR of losing money or losing your gains are a strong motivator to exit a long stock position and most short sellers are playing the opposite side of the long trade, capitalizing on your fears.

Example: Assume you own 1,000 shares (long) of a stock for 1 month and the trade is working out nicely. You have $5,000 “paper profit” after a month and things are looking great (I say paper profits because you haven’t yet “realized” the gains and exited the trade, they are currently “unrealized”).

Earnings came out that evening after the market close and not much activity in trading after hours, so far so good. The next morning, you login to your account, your $5,000 profit is now $-3,000 POSITIVE FIVE THOUSAND IS NOW NEGATIVE THREE THOUSAND! Just like that, you gave up a month worth of gains and then some, the stock moved $8/share overnight “gapping down” and your stomach sinks.

You learn on Twitter that the earnings call wasn’t what Wall Street expected — your company missed both revenue and EPS estimates AND lowered their overall stock guidance for the year. You realize this isn’t a quickly recoverable situation and the stock price is tanking badly during the first 2 hours of trading as other traders are dumping the stock just like you want to — what would you do?

Do you see how fear takes over and someone shorting the other side of your trade can quickly make a profit? By shorting the stock, even though the fees/risk are higher, it would make for a great short term trade to capitalize on the bad news where are the longs are trapped in a sinking stock price.

Most traders I know specialize in the “Parabolic Short” moves…this is a stock that has gone up and up over little to no news and is due a “pullback”. They wait for the stock to rollover on the 5-minute intraday chart and then jump in “short” and “size in”. They enter orders in 4 or 5 batches until their optimal size (10,000 or 25,000 shares) is reached.

Rarely do I hold a short overnight because the overnight risk of the stock gapping in the opposite direction. Shorts can get destroyed quickly. Panicking shorts “buy to cover” which pushes the price higher and higher as more and more shorts panic and exit their position for a loss.

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