Why Retail Investors Should (Usually) Never Short
The first-principles difference between simply holding a stock and shorting it. A short is NOT just the reverse of a long.
Hey guys. This is a bit of a different article today. I’ll sometimes write about some first-principles lessons I learn as an investor in hopes that you can learn something too.
I got into shorting earlier this year and I ended up losing a few hundred bps in total. Now, I’ve stopped and closed them all to focus purely on longs. My PnL is still fantastic thanks to my longs but I thought this was a worthy learning experience.
Shorting (particularly unpaired short theses) is not the same as long-ing! They require different mindsets, different skills, and a different foundational framing. A fantastic long investor can be a terrible short investor (me) and vice versa.
And yeah I do publish short theses and will continue to do so even if I am not short anything most of the time. This is actually part of a prudent short-seller’s strategy as you’ll see in the writeup. No contradiction here.
So yes, this is an entire textbook chapter article about shorting. Just shorting and the first principles and philosophy behind it. Nothing else. Enjoy!!!
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Contents
Path Dependency
A Good Thesis Does Not Make a Good Trade
Price-to-Value Convergence
How Long vs. Short Investors Enter a Trade
Paired vs. Unpaired Shorts
Why I Am a (Mostly) Long-Only Investor
Path Dependency
Path dependency is a concept borrowed from mathematics and physics, and it shows up anywhere the history of how a system evolved matters to the final outcome, not just the endpoints. A path-independent process only cares about where you start and where you end. A path-dependent process cares about every step in between. Gravitational potential energy is path-independent: the energy it takes to lift a book onto a shelf is the same whether you lift it straight up or walk it around the room first. Friction is path-dependent: the energy lost to dragging that book across the floor depends entirely on the route you took to get there.
In economics the term gets used to describe why certain outcomes are locked in by the sequence of events that produced them. QWERTY keyboards are the standard not because they’re optimal but because of the specific historical path of typewriter adoption. The concept generalizes to any system where the trajectory, and not just the terminal state, determines what you end up with.
Investing sits on both sides of this distinction, and the side you sit on depends entirely on whether you are long or short.
A long position is path-independent. If you buy a stock you believe is worth $200 at $100, the only thing you need to be right about is the destination. The path the stock takes to get there is almost irrelevant to your eventual P&L. It can trade down to $60 first. It can sit flat for three years. It can rally to $150, give it all back, and then finally grind to $200 in year five. None of these paths change the fact that you bought at $100 and eventually exited at $200. If anything, the adverse paths are gifts, because they let you buy more at better prices. Your cost basis improves, your future returns improve, and when convergence finally arrives you have monetized the volatility rather than suffered it. Time is on your side because the business compounds, pays dividends, buys back stock, or gets taken out. The forcing functions of corporate finance drag price toward value on a timeline that does not need to be yours.
A short position is path-dependent in exactly the way that a long position is not. If you short a stock at $100 that you believe is worth $0, you cannot simply wait for the destination. The path matters because every point along the path has the capacity to end the trade before the thesis plays out. If the stock rallies to $200 first, you are margin called, forced to cover at the top, and the $0 destination arriving six months later is a story you tell at dinner rather than a number in your P&L. If the stock sits flat for two years, borrow cost has eroded your return even if you are eventually right. If the stock grinds down slowly, you are paying to hold the position the entire time. There is no mechanism by which a worthless business is forced to trade at zero. There are only participants who decide to sell, or refuse to buy, and that decision can be deferred indefinitely.
The practical consequence is that a long thesis only requires certainty about the endpoint, while a short thesis requires certainty about the endpoint AND the trajectory. You have to be right about what the business is worth, and you have to be right about how the market gets from here to there, and you have to survive every intermediate price the market decides to print along the way. These are three separate analytical problems, and any one of them being wrong kills the trade even if the other two are correct.
This is why a correct thesis does not make a good short. A thesis is a claim about the destination. A short is a claim about the destination, the path, and the clock, all at once.
Below we discuss why a correct thesis is only the starting point of a short and not the trade itself, the structural reason price converges to value on the long side and refuses to on the short side, the entirely different entry criteria that path dependency forces on long versus short investors, the taxonomy of paired and unpaired shorts and what basis risk has to do with running a real hedge fund, and finally why all of this leads me to operate as a mostly long-only investor despite having spent considerable time building out a short watchlist I have not deployed.