The Motley Fool

Short-Selling Stocks: A Risky Strategy

Image source: Getty Images.

Buy low and sell high is the conventional strategy of stock investors. You purchase stocks in the hope their prices will increase then you make profits. Long-term investors buy and hold dividend stocks for recurring income streams with less emphasis on capital appreciation.

However, one strategy average investors must not do or avoid is short-sell stocks. Seasoned traders or famous investors profit from stocks they anticipate to underperform and decrease in market value. You engage in short selling if you capitalize on the predicted downfall of individual equities. Some market players would seize opportunities and attempt to profit from the decline of a security’s market price.

A reverse of the golden rule

Short sellers do the reverse of the traditional or golden rule in stock investing. The modus operandi is to sell borrowed stock at its current market value and then repurchase it later. When the stock price drops, the difference is the profit. In a short sale, traders pay interest on the borrowed stocks.

Traders must open a margin account to borrow stocks. The broker often sets the margin account maintenance fee, usually about 30% of the equity’s value. Once the transaction is complete, the trader returns the borrowed shares to the broker. The trader’s profit is net of the broker’s fees any interest due from there.

Ground-breaking battle

In the U.S., video game retailer GameStop is the hottest stock in 2021. The business is losing money due to the shift to online sales. Despite the impending closure of 450 stores, small investors (through the trading app Robinhood) saw a buying opportunity. Meanwhile, Wall Street investors saw a chance to short sell.

GameStop’s price is soaring like crazy because the cult followers keep scooping more shares. Established short-sellers are losing, although the bet that the sky-high price would eventually fall is still on. It’s a war of attrition and a ground-breaking battle between established, diversified players and a new breed of investors.

Steer clear of short-selling

Growth investing is a less-risky strategy. A leading AI-powered learning platform has a long runway for massive growth. Docebo (TSX:DCBO)(NASDAQ:DCBO) is one of the TSX’s hottest tech stocks, gaining significant investor attention.

Docebo’s share price was only $16.57 a year ago. In 2020, the tech stock’s total return was 387%. Had you invested $50,000 on December 31, 2019, your capital would be worth $209,505.59 today since the price is more than $71. The $2.33 billion cloud-based Software-as-a-Service (Saas) learning platform received several recognitions and accolades last year.

In Deloitte’s Enterprise Fast 15 program, Docebo was among the Technology Fast 50™ and Technology Fast 500™ awardees. The company counts as one of Canada’s fastest-growing technology companies. Apart from its high revenue-growth percentage over the last four years, Docebo owns an innovative proprietary technology and disrupts the tech industry.

Docebo provides an easy-to-use, highly configurable learning platform with end-to-end capabilities. The platform enables enterprises to apply new technologies to the traditional corporate learning management system (LMS). Analysts expect the global LMS market to grow at a 20.6% compound annual growth rate (CAGR) clip from 2021 to 2026.

Risky strategy

The miracle of compounding is absent in the risky short-selling strategy. Similarly, losses could far exceed the limited profit. It’s better to invest in companies with visible growth potentials.

Speaking of the risky short-selling investment strategy...

This Tiny TSX Stock Could Be the Next Shopify

One little-known Canadian IPO has doubled in value in a matter of months, and renowned Canadian stock picker Iain Butler sees a potential millionaire-maker in waiting...
Because he thinks this fast-growing company looks a lot like Shopify, a stock Iain officially recommended 3 years ago - before it skyrocketed by 1,211%!
Iain and his team just published a detailed report on this tiny TSX stock. Find out how you can access the NEXT Shopify today!

Click here to discover how!

Fool contributor Christopher Liew has no position in any of the stocks mentioned.

Two New Stock Picks Every Month!

Not to alarm you, but you’re about to miss an important event.

Iain Butler and the Stock Advisor Canada team only publish their new “buy alerts” twice a month, and only to an exclusively small group.

This is your chance to get in early on what could prove to be very special investment advice.

Enter your email address below to get started now, and join the other thousands of Canadians who have already signed up for their chance to get the market-beating advice from Stock Advisor Canada.

I consent to receiving information from The Motley Fool via email, direct mail, and occasional special offer phone calls. I understand I can unsubscribe from these updates at any time. Please read the Privacy Statement and Terms of Service for more information.