Asymmetry in shorting – Is shorting more risky?

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alvin
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Joined: Sat Sep 26, 2009 1:52 pm

Asymmetry in shorting – Is shorting more risky?

Post by alvin »

Other than the direction, I used to think that short selling is the same on the long side.

I found that is not true and here is why

When you short, you can lose more than your capital

Imagine you short a stock at $50 and it goes to $0. Your gain is $50 or 100% gain. This is the maximum gain you can get. On the other hand, if the price continues to go up to $100, or $200, or $300… You can lose more than your capital with 200% or 400% or higher – the sky is the limit! And this is without any leverage. It is definitely not a position you want to be in.

Yes. Of course you can put a stop loss to it. In fact, you MUST always have a stop loss when you short anything.

On the long side, you buy a stock at $50, the maximum loss you can potentially realised is 100% of the $50 you invested. If it goes to $200, you can enjoy 400% gain.

This asymmetry in profit/loss profile is depicted on the chart below.
Image
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