The two biggest truisms of short-selling are not actually true.
This weekend, Jim Chanos, famed short seller and director of Kynikos Associates, was a guest on Barry Ritholtz’s Master in Business program on Bloomberg Radio.
At one point in their discussion, Ritholtz brings up the famous anti-short-selling argument that when you short a stock, the most you can make is 100%.
Chanos quickly rejects this idea.
As Chanos explains:
If you start with a short position at $US100 with no other cash in your account, and you short the stock and it goes down to $US50, you can, without adding any more cash capital to the account, short additional shares. And if it keeps going your way, you can compound your return.
Ritholtz notes that you still face the same types of risks that many bring up when discussing short-selling, and which we’ve written about before, namely margin calls, short squeezes, and the like.
Chanos says that this is still the case, but as to the statement that you can’t make more than 100% on initial capital on a short position: “That’s not true.”
Chanos also takes on another accepted “truth” regarding short-selling: that short sellers face infinite losses.
For one, if you’re short, you can put in stop-losses, or automatic price levels at which you cover your short, thus preventing the theoretically infinite losses. But Chanos also brings up another argument, which is that if you’re investing in a partnership, and you’re a limited partner, you can lose only what you put up.
Chanos and Ritholtz spend a lot of their conversation discussing psychology and behavioural finance, and Chanos wraps up the debunking of these two market adages saying:
These are examples of thinking that that are accurate on their face, but in practicality they’re inaccurate. Because you structure things to not let that happen and you can actually get protection through the structure of the investment vehicle to obviate those risks. But having said all that, they do play into behavioural finance.
Ritholtz’s series is fantastic, and it is required listening for anybody who wants to hear real talk from real market pros.
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