By Sandra Alberti
The conventional investor’s target is to buy low and sell high. The short-selling investment strategy is reversed; the investor buys high and sells low.
As an example, if you believe that the XYZ company’s stock price, selling for $10.00, is overvalued, you could short XYZ, guessing it’s price will go down.
You call a broker and ask him to short 100 shares of XYZ at $10.00 per share. The broker lends you the shares, borrowing them from his firm’s own inventory or other sources, and sells them receiving $1,000 in proceeds that is held by the brokerage to secure the loan.
Assuming that in the upcoming months XYZ drifts down to $5.00 per share, at that point, you buy 100 shares for $500.00 to replace the borrowed shares. The $500.00 profit is the difference between the sale price $1,000, and the cost of purchasing stock to replace the borrowed shares.
What happens if you misjudged XYZ and the stock’s price climbs to $15.00? You’ll probably decide that it’s time to limit your exposure and buy 100 shares for $1,500 to pay back the broker. Your investment mistake would cost you $500.00. In both cases you still would need to pay the brokerage fees.
We do not believe in shorting, simply because of the risk exposure.
Example: In a worst case scenario, if you had invested $1,000 conventionally as described above, and this company went out of business, you would lose your $1,000 investment. This is the maximum loss you could endure.
On the other hand, if you had used the short-selling strategy, made a wrong decision, and the price of the XYZ Company stock went up, and for whatever reason continued to go up, your loss would be unlimited. Many companies today are being bought up and taken over without any prior notice to investors because of the opportunity they present to the parent company. Many times the stock prices are bid up 30 to 50 percent almost instantly. This could cause a loss to the investor of three to five times, or more, the original investment.
We at PCI do not short any stocks simply because of the high risk placed upon your account. It doesn’t make a lot of sense to me to invest in something where the potential loss is significantly more than the opportunity to succeed. We say this often, but perhaps never often enough: We structure every portfolio to meet the individual client’s objective with a strategy of buying undervalued companies with outstanding growth potential. These stocks are chosen after many long hours of research by our advisory staff. We also purchase the same stocks for our family, our friends, and ourselves.
DISCLAIMER:
Information has been obtained from sources deemed to be reliable. Pearson Capital, Inc. makes no guarantee as to the accuracy or completeness of this data. Information is provided for informational purposes only, and Pearson Capital, Inc. shall not be liable for any errors or omissions, or for any actions taken in reliance thereon.
