There is no shortage of acronyms, analyst-ese and other jargon in the investment world.
One couplet that stirs up a lot of interest is 'long-short'. So what exactly is 'long'? And what is 'short'? And should you care?
There's nothing special about those terms. I'm not even sure where they originated.
But, in brief, you 'go long' if you think an asset (usually, but not always, a share price) will increase in value. And, perhaps not surprisingly, 'going short' is an approach taken when you expect a share price to fall.
But let's break it down a little further.
Go long, young man
When you 'go long', if a share price goes from $1 to $1.50, you'll make a 50% return.
If you 'go short', you're taking the opposite bet. You're betting that a company's share price will be lower in future — likely significantly so. When you 'go short', if a share price falls from $1 to $0.50, you'll make a 50% return.
Of course, if the reverse happens in each case, you'll lose money. So, really, the same skills are used to 'go short' as to 'go long', right?
Not so fast! There are a couple of important things to consider. Unless you are a member of our Motley Fool Share Advisor service, of course, in which case the hard work is done for you.
When you 'go long', your downside is limited to the total of your investment. If your company's share price goes to zero, you lose 100%. That's bad. But when you go short, the $1 share price can rise to $3, $5 or $10, and you're on the hook for the difference!
How does that work?
Well, essentially when you 'go short', you have to borrow someone else's shares. And you have to give them back at some point. So, if you've borrowed a share at $1, and you have to give it back when it hits $10 — you have to give the lender the full value!
If that's not bad enough, you also need to pay to borrow the shares. So not only can you be out of pocket for the difference, but also the cost of borrowing them — effectively, you're paying interest.
I hope it's starting to sound a little less worthwhile by now.
When you combine those two elements, it's even possible to be right about your view that the company's share price will decline, but still lose money because the borrowing cost outweighs the share price fall — or the share price fall takes longer to materialise than you can afford to pay the interest cost
That makes the challenge of investing much harder. It doesn't just double the difficulty… it squares it.
And lastly, you're betting on a share price fall, in a broader context of inexorable (even if bumpy) rises in share prices. So you have to be more right with your short than if you went long on another company — and you're swimming against the tide.
Some investors have been able to make a career out of shorting. Others have come a cropper in spectacular ways, being wiped out when the market moved against them.
When you go long, you have time, quality and value on your side. But when you go short, you're betting that the mix of (too high a) price and (poor) quality will come to fruition before the passing of time (and broader market increases) steal your returns away from you, and possibly leave you poorer.
A personal observation
I don't like the idea of short-selling. The public markets were designed to allow companies to raise capital and for investors to exchange an ownership interest in those companies in an orderly (and regulated) marketplace.
I don't think there's a place for short-selling in investing. In my view, where there's no value being created by a financial transaction, it's effectively just gambling by blokes (and women) in suits, given a veneer of respectability by being conducted on the ASX.
That's not to say all short-sellers are reckless speculators. Far from it. Some even make money from it, by using their considerable skills to identify overpriced companies or outright frauds. I just don't think that it adds any value to our financial markets, and shouldn't be allowed.
Which option will you take?
In short — if you'll excuse the pun — it's theoretically possible to make money from short-selling… I think there are just easier (and more profitable) ways to invest — and suggest you do the same.
