Being contrarian means taking the opposite view to most people.

In the stockmarket, that can be a profitable move to take, rather than sticking with the investing herd. But being contrarian for the sake of it can also be very dangerous. The market does get it right more often than not.

Investors taking short positions in shares are often thought to be contrarian, given they are betting that the share prices will fall, rather than just buying and holding shares for the long term and letting the company grow earnings over time which will hopefully see the share price rise.

However, shorters usually expect their trades to pay off in much shorter timeframes.

The main problem they face is that if the share price rallies – perhaps because of some good news – shorters are usually forced to jump into the market and buy stock, perhaps further pushing the share price up – in what is known as a ‘short squeeze’. The higher the price goes, the more shorters are forced to buy stock – resulting in a catch 22 situation.

6 years ago, these were the top 10 shorted companies.

    Share price  
Company Shorted 13 Sep 2010 Today Difference ($)
Fairfax Media Limited (ASX: FXJ) 11.8 1.51 0.94 -0.57
Newcrest Mining Limited (ASX: NCM) 7.7 38.49 21.69 -16.80
JB Hi-Fi Limited (ASX: JBH) 5.8 22.35 28.85 6.50
Perpetual Limited (ASX: PPT) 5.5 30.58 45.23 14.65
Aristocrat Leisure Limited (ASX: ALL) 4.6 3.8 14.78 10.98
Avoca Resources – Merged to form Alacer Gold (ASX: AQG) 4.5
Crane Group – Acquired by Fletcher Building (ASX: FBU) in 2011 4.4
David Jones – Acquired by South Africa’s Woolworths in 2014 3.6
Western Areas Ltd (ASX: WSA) 3.6 5.53 2.52 -3.01
Elders Ltd (ASX: ELD) 3.6 6.75 3.85 -2.90
Alesco Corp – Acquired by DuluxGroup (ASX: DLX) in 2013 3.3

Source: S&P Global Market Intelligence

Clearly, had the shorters kept their positions in Aristocrat, Perpetual and JB Hi-Fi, they’d be underwater now. However, Newcrest, Fairfax, Western Areas and Elders would have paid off handsomely, with their share prices down 38%, 44%, 54% and 43% respectively.

The other companies could have seen shorters stuck in a short squeeze if the acquisition was announced shortly after September 2010. That’s the problem with shorting a stock – often if the outlook for the company is not great, then they can become acquisition targets.

Foolish takeaway

Not everyone can successfully short stocks – much like not everyone will be a successful investor. Additionally, the most a shorter can gain is 100% if the stock they are shorting goes to zero, unless they leverage up. Buy and hold investors can see gains of 10 times that or much, much more.

 

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.