With the market having recently fallen around 14% this year, many investors are wondering if they missed a rare opportunity to make a bundle by shorting the market or individual stocks. While it’s true that a prescient investor could have coined money by well-timed shorting of stocks this year, it’s far from a sure thing. Even sophisticated professional investors can be “burned” by shorting stocks. Recall that it’s estimated that hedge funds and other professional investors lost about $9 billion shorting GameStop (GME) and AMC Entertainment (AMC).

Let’s review shorting. When an investor buys a stock he owns a piece of a business, something real. Shorting stocks is quite different. With this, the investor doesn’t own anything. He borrows stock from his broker and sells the borrowed stock. He hopes to be able to buy it back later at a lower price. A margin account is required. This strategy has risks that are different from owning a stock.

The biggest risk is, at least theoretically, that the investor's losses are unlimited. If you own a stock and it goes bankrupt the most that you can lose is all your investment. If it drops 50%, it must double for you to be even; however, you can hold the stock for as long as you want, and time is on your side. Neither of these is true when shorting a stock.

For example, if you shorted Tesla (TSLA) in January 2020 at $130 a share and bought it back in January 2022 when it was it was about $1,200, you would have lost $1,070 a share, or $107,000 on a100 share short. This is theoretical because your broker would’ve closed out your position earlier unless you continued to shovel money into your account to cover the loss.

When you buy stocks, the odds are on your side. The market is higher at the end of a calendar year about 70% of the time. When shorting, the odds are against the investor for the same reason. This means that shorting is intrinsically a short-term bet that the stock will at least temporarily decline. Time is not on the investor’s side when shorting as it is when buying.

When you buy a dividend-paying stock you benefit from the dividends. This isn’t true when you short a stock. Since you borrowed the stock from the broker and sold it, you are responsible for paying the broker the dividends. This adds to the costs of the transaction and will decrease any profit or increase the amount of any loss. This reinforces the short-term nature of shorting, as the longer you are short the more dividends you pay.

Professional money managers sometimes short stocks to hedge their risk. They may, for example, select a market sector and buy the “strongest” companies in the sector and short the “weakest.” The hope to profit no matter what happens. If the sector does well the strong should do better than the weak and if it falls the weak should do worse than the strong. This sophisticated strategy isn’t for typical investors.

All data and forecasts are for illustrative purposes only and not an inducement to buy or sell any security. Past performance is not indicative of future results. If you have a financial issue that you would like to see discussed in this column or have other comments or questions, Robert Stepleman can be reached c/o Dow Wealth Management, 8205 Nature’s Way, Lakewood Ranch, FL 34202 or at rsstepl@tampabay.rr.com. He offers advisory services through Bolton Global Asset Management, an SEC-registered investment adviser and is associated Dow Wealth Management, LLC.

This article originally appeared on Sarasota Herald-Tribune: ROBERT STEPLEMAN: Considering shorting stocks? Let's review the risks