32 - Shorting Stocks is a Negative-Sum Game (Investing First Principle)

Mental Models discussed in this podcast:

• Zero Based Thinking
• Negative Carry
• Opportunity Cost
• Hidden Costs

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Shorting Stocks is a Negative-Sum Game (Investing First Principle) - Show Outline

The full show notes for this episode are available at https://www.diyinvesting.org/Episode32

Mental Model: Zero-Sum Games

• Any gains by one participant must be offset with losses by other participants.
• The sum total of all value for all participants is equal to zero

Why shorting Stocks is a Negative-Sum Game

• Stocks as a whole provide a positive expected value
  • Shorting stocks is the opposite. Now you have a negative expected value. 
• Further complicated by the issue of "negative carry."
  • When you purchase stock in a company the only cost of holding it, is an opportunity cost. What you could have spent the money on or what alternative investments you could have chosen. This opportunity cost is an implicit or hidden cost.
  • Shorting is different.
  • The act of shorting a stock involves two key explicit costs, both of which create negative carry.
    • Borrowing Costs
    • Dividend Payments

Other Key Problems with Shorting

• Time Horizon Matters a lot:
  • You can be right and still lose money
• Everyone is working against you. CEO, Employees, debt markets, other investors, etc...
• The economy generally gets better over time. You're fighting the tide.
• Like gambling in a casino
  • "The House Always Wins."