A co-worker and I had a heated debate over this very question. He feels that shorting a stock is much riskier because you could actually lose much more than your initial investment and the most you could gain was limited to the stock going to zero. I told him that shorting was no riskier other than the fact that 'in general' most stocks 'tend' to move higher in price over time. Other than that, I told him that even if I shorted GOOG for example at 100, and hit my head snowboarding and was in a coma since that time that my broker would have issued a margin call on the short position and would have subsequently sold off to maintain 50% margin in my account. He then said that brokers don't do that, and I said of course they do, and if they don't then you are not obligated to the short position beyond your initial investment. And, I told him that even with GOOG going up like that, that did not make the short any riskier in general. I only lose in the short position because I kept it open and did not cover, just the same as if I had been long on the stock and it dropped and didn't sell it. I think it is interesting how most people view shorting as so much riskier than being long. Granted, I do think that the reason they call it 'short' ing is because most folks don't leave the short position open for a long time whereas longs are meant to hold for a long time. Also, you do have to pay margin interest to short the borrowed stocks and must pay any dividends that come due as well. I did short the snot outta the airlines in 03 and did well with that, but the only recent short I had was RIMM at 74 and DHB at 11.44.
shorting is less riskier when there is a bear market. in a bull market, it's very hard to fight the tide. even fundamentally weak stocks have a tendency to rise in a bull market.
You might be OK with the top 500 stocks or so. But when you get a tiddler that pops 300% in one day (as I have had) you'd better be long that one! I cannot see how anything but the most liquid intruments would ever be worth shorting on a risk/reward basis for a purely directional play.
My take on things is that if you want to be short, and limit your downside risk, why not use options instead?
with options though you have to hit the price within a certain time frame. I had shorted DHB at 11.44. I thought for sure it would be between 4-5 by April 15th this year. I was right that it would hit that price, just the timing was off a few months.
I recommend the following rules: Don't short the stocks that are not generally available to short. Don't short the stocks that their volume is less than 500K. The desirable is over 1M. Don't short a stock that caught your eyes because it was going up and you believe that it is overvalued and it should go down. Wait for some signs of topping. Shorting can be risky as going long. In theory Shorting is riskier but that is the limit and limit (infinity) never happens in real life. Shorting usually has a quicker profit if you are right.That is my experience. FYI: My problem is that I am more in favor of trying to find stocks to short than going long.
There is nothing inherently more or less risky about shorting versus going long. The liklihood of ruin (an account going to zero) is going to be VERY high if you lack stringent money management rules. The absolute, first, and most important decision any savey business person does when they enter into an investment is determine what they are willing to lose BEFORE they enter that investment. It doesn't matter if you're investing in a retail business, an oil well, a stock, or whatever. Making this determination is the only way you can set a risk/reward ratio in advance. If you don't know where you're getting in and why and where you're getting out and why, then you're gambling (also known as hoping). Getting back to the original question: asking about risk in long versus short creates the illusion that it's either one or the other. What if you add in the possiblity of NO market postition. Some will argue that's the least risky. But, what about the risk of NOT profiting from the investment/trade in question. You see, the question is loaded with lingquistic presuppositions that are taken for granted. The reality is you have to have a very precise definition of what risk is. If you're interested in more on these ideas, I reccomend Justin Mamis, The Nature of Risk. For someone caught in these illusions it can be quite an eye opening read.
how do you determine if a stock is generally not available to short? I have an IB account and if I want to short e.g. "OSTK" and it says shares are not available to short, I won't try to short it through another broker that might have the shares. If I am so determined to short it, I do it though selling PUTs. Preferably I will try to find another stock.