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Nov. 27, 2015, 9:16 a.m. EST

Why you should never short-sell stocks

Famous investors do it, but the average investor has too much to lose

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By Philip van Doorn, MarketWatch


Bloomberg News/Landov
Don’t place a concentrated short position on a stock unless you are prepared to do some cliff diving.

The financial media love when big-time professional investors, such as Bill Ackman or David Einhorn, say they have shorted a stock, because it means there could be open warfare between the investors and the companies.

Shorting, or short-selling, is when an investor borrows shares and immediately sells them, hoping he or she can scoop them up later at a lower price, return them to the lender and pocket the difference.

But shorting is much riskier than buying stocks, or what’s known as taking a long position. When you buy shares of company, you obviously hope they will rise in the short term or over a long period or maybe that they will just provide dividend income.

When you “go long,” your maximum possible loss is 100%, or your entire initial investment. That can happen, for example, if a company goes bankrupt.

But if you have a short position, there’s no limit to how much money you can lose if the shares rise . If the share price increases soon after you place a short position, you could quickly “cover” by buying back the shares and returning them to the investor you borrowed them from. If you’re lucky, you might not lose very much.

But an investor named Joe Campbell was not so lucky when he placed a $37,000 short position on KaloBios Pharmaceuticals Inc.  earlier this month, only to find out a day later that the shares had shot up about 800% after Turing Pharmaceuticals CEO Martin Shkreli gained control of a majority of KaloBios’ shares.

Read: KaloBios short sellers facing squeeze as CEO Shkreli says will no longer lend stock

Oops. Campbell pleaded for assistance, saying he might have to cash in his and his wife’s 401(k) to cover his position, since his broker was unable to react quickly enough to close out the trade when his account balance was wiped out. But he received little sympathy from other investors, as you can read on his GoFundMe page .

‘Being greedy’

“He obviously had a lot of conviction when he decided to do it,” said Brad Lamensdorf, co-owner and co-manager of the AdvisorShares Ranger Equity Bear ETF /zigman2/quotes/210556377/composite HDGE -1.64% .

The AdvisorShares Ranger Equity Bear ETF has about $140 million in assets and typically has 40 to 60 short positions on companies with market capitalizations of at least $1 billion. This is one way for individual investors to short stocks of companies that Lamensdorf and co-manager John Del Vecchio think are headed lower, based on analyses of their financial reports.

“He was just being greedy,” Lamensdorf said of Campbell in an interview Thursday, adding that “concentration kills.”

“He was massively concentrated in a micro-cap, which is another major red flag for any investor,” he said.

George Schultze, founder and CIO of Schultze Asset Management in Purchase, N.Y., said “it is that kind of uninformed investor that makes a market opportunity for all of us professional investors, not only on the short side, but on the long side.” His company has about $250 million in assets under management.

Schultze said in an interview Thursday that his firm “does a lot of work identifying short candidates.”

/zigman2/quotes/210556377/composite
US : U.S.: NYSE Arca
$ 25.80
-0.43 -1.64%
Volume: 77,341
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