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!!!

short-ing

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Contents

1. Path Dependency

2. A Good Thesis Does Not Make a Good Trade

3. Price-to-Value Convergence

4. How Long vs. Short Investors Enter a Trade

5. Paired vs. Unpaired Shorts

6. 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.

A Good Thesis Does Not Make a Good Trade

There is a distinction that gets collapsed in most retail and junior-professional thinking about investing, and the cost of collapsing it is much higher on the short side than on the long side. The distinction is between a thesis and a trade.

A thesis is a claim about a business. The company is overearning. The moat is eroding. The TAM is shrinking. The accounting is aggressive. The margin structure is unsustainable. Management is incentivized to destroy value. These are all statements about the underlying enterprise and its trajectory as a going concern.

A trade is a claim about the market’s price for that business over a specific window. It is a prediction that the quoted price will move from where it is now to somewhere else, that this move will happen before borrow and opportunity cost erode the position, and that the path between those two prices will not force you out of the position before you are paid.

Longs can afford to blur this distinction because the forcing functions of corporate finance do a lot of the work for them. If the thesis is right and the business compounds, the trade tends to work eventually, even if the entry was mediocre, the timing was early, and the path was ugly. The long investor is riding a vehicle that drags price toward value on its own schedule, and the thesis and the trade converge because the mechanics of the security are designed to make them converge.

Shorts do not get this luxury. On the short side a correct thesis is a necessary but nowhere near sufficient condition for making money. You can be completely right about the business and still lose. You can be right about the direction and still lose. You can be right about the direction AND the magnitude and still lose, if the timing is wrong or the path is too volatile. The thesis is one input into the trade, and the trade has several other inputs that are doing independent work, and any of those other inputs going against you is enough to produce a losing position.

The classic examples make this vivid. Ackman was directionally correct on Herbalife in the sense that the business was doing what he said it was doing. The trade lost him roughly a billion dollars because the path and the clock did not cooperate. Einhorn was right on the accounting at several companies that nonetheless rallied for years before any of his thesis points were reflected in the price. Chanos was right on Tesla as a business analysis for most of the last decade and it is one of the most expensive correct theses in the history of short selling.

The reverse is also true, and worth noticing. You can have a mediocre or even wrong thesis and make money on a short if the trade itself is structured correctly. A stock that is merely fully valued, held by weak hands, entering a window of negative flows, with a near-term earnings catalyst that is likely to disappoint, can be a profitable short even if the underlying business is fine. The trade worked. The thesis was secondary.

This is what professional short sellers mean when they talk about “good thesis, bad trade.” They are pointing at the gap between having correctly diagnosed the company and having correctly structured a position to profit from that diagnosis. The gap is real, it is large, and it is where most amateur short sellers lose money. They do the work on the thesis, they get the thesis right, they short the stock, and they discover that being right about the company was only a small part of what the position required.

The long investor’s instinct is to treat “I am right about the business” as dispositive. On the long side, that instinct is mostly correct, because the mechanics of equity ownership will eventually reward a correct business view. On the short side, that instinct is the single most reliable way to lose money while being right.

Price-to-Value Convergence

The path dependency asymmetry has a deeper root, which is that price-to-value convergence is mechanically underwritten on the long side and entirely absent on the short side. Most investors internalize the idea that markets eventually get it right, but rarely stop to ask what actually makes that happen. When you examine the mechanisms, they all run in one direction.

On the long side, the forcing function is simply that the cash the business generates belongs to the shareholders. Whether it comes back through dividends, through buybacks, or accumulates on the balance sheet earning interest, every dollar of free cash flow is economically owned by the equity. This is not a market convention, it is the legal structure of the corporate form. Over a long enough horizon, the stock cannot trade meaningfully below the present value of the cash it will return to its owners, because if it did, a private buyer, an activist, or management itself would close the gap. The business is continuously producing value that accrues to holders, and that accrual is what pulls price toward value over time. You do not have to convince anyone of anything. You just have to own the claim on the cash.

Now apply the same question to a short. What forces a stock that is worth nothing to trade at nothing? The answer is that there is no mechanism. There is no dis-dividend that extracts cash from shareholders and hands it to shorts, no dis-buyback that dilutes holders by issuing free shares, no compounding process that erodes book value on a schedule. The only way an overvalued stock goes down is if participants decide to sell or stop buying at the current price, and beliefs can remain unupdated for years. Worse, the long-side mechanisms actively work against shorts. Buybacks remove shares from the borrow pool and push the price up. Dividends get paid through. Insider buying moves positioning against you. Every force that guarantees long convergence is a short-side headwind.

So longs are mechanically underwritten by the corporate form, while shorts are underwritten only by other participants changing their minds in a specific direction within a specific window. One is a structural bet, the other is a behavioral bet.

The same asymmetry shows up in what you do when price and value diverge. Both sides are ultimately paid in price, not value, because you cannot deposit a DCF into your brokerage account. But on the long side, if price moves against you while value holds, you can buy more at a better basis and actually monetize the gap when convergence eventually arrives. Adverse moves become a feature of the strategy. On the short side, the equivalent move is adding to a losing position at a worse basis, which is exactly what blows up short sellers. The mechanic that rewards patience on one side punishes it on the other. Longs have an embedded option that converts time and volatility into profit. Shorts have an anti-option that converts the same two inputs into ruin.

How Long vs. Short Investors Enter a Trade

Everything above forces a different entry process on each side, and the difference is sharper than most investors realize. What a good short looks like and what a good long looks like are almost unrecognizable to each other as the same activity.

A short investor cannot enter on thesis alone. Because the position is path-dependent, carries negative, and has no corporate forcing function pulling price toward value, the entry has to be underwritten to a specific risk-reward skew over a specific window. In practice this means three things. First, a target price, because the bounded upside of a short (capped at 100%) has to be weighed against a specifically modeled downside, and if the stock has more room to rally than it does to fall over the relevant horizon, the trade is bad regardless of how good the thesis is. Second, a target date, because every day the position exists is a day of paying borrow, paying dividends through, and bearing squeeze risk, so the thesis has to resolve inside a window short enough for the expected return to clear those costs. Third, catalysts, because absent a forcing function the only thing that moves price toward value is a specific event that makes other participants update their beliefs. Earnings, guide-downs, covenant breaches, regulatory actions, accounting restatements, and insider selling all qualify. Absent a catalyst, you are paying carry to wait for someone else to notice what you noticed, with no guarantee they ever will.

This is why a good short investor can maintain a watchlist of forty solid short theses and not have a single one on. The thesis being correct is a prerequisite, not a trigger. The trigger is the stock reaching a price and setup where the near-term skew is favorable. A business you believe is worth $10 trading at $25 might be an obvious short thesis and a terrible short trade, and the same name at $40 with a looming earnings catalyst might be the trade of the year. Nothing about the business has changed. What has changed is the path forward. Shorts are entered on price, on timing, and on the specific shape of the risk-reward from here, which is why the activity feels surgical even when the underlying view is broad.

A long entry is almost the opposite. It is bigger in scope and less precise in execution. The long investor is looking for a large market opportunity paired with a durable competitive advantage and a price that implies a sufficient margin of safety. Timing does not need to be specified because the forcing function described in the previous section is doing the work. Catalysts are not required because the business is compounding on its own schedule, and every quarter that passes makes the intrinsic value larger whether the market notices or not.

What replaces timing and catalysts on the long side is the size of the expected return. A long-only investor focused on multibaggers will typically not take a position unless the expected return is something like a hundred percent or more, because the abstract margin of safety in the value is what absorbs all the path risk, the timing uncertainty, and the compounding errors in the thesis. If you are right about a triple in five years, you do not need to be right about which year, which quarter, or which catalyst delivers the move. The size of the prize carries the imprecision of everything else. If you are wrong about the triple but still right about the doubling, you are fine. If you are wrong about the doubling but still right about the business compounding, you are fine. The margin of safety absorbs the error.

Shorts do not have this luxury. A short cannot be half right on the path and still make money, because the path is the trade. So shorts demand surgical entries, specific catalysts, and calibrated risk-reward, while longs demand scale of opportunity and durability of moat. Both are disciplined, but the discipline runs along completely different axes. One is precision in price and time. The other is magnitude in value and moat.

Paired vs. Unpaired Shorts

Once you accept that shorts are bets on price within a window rather than bets on value over a horizon, a useful taxonomy emerges. Not all shorts are doing the same thing. Some are taking standalone bets on a specific name going down, and others are using the short as one leg of a larger structure. The distinction matters because the entry rules, the risk-reward, and the bar for “good trade” are all different across the two.

An unpaired short is what most people picture when they hear the word. You short a single name on its own merits, hoping the stock goes down in absolute terms. Your P&L is the stock price decline net of borrow and dividends paid through. Everything in the previous sections applies in its purest form. You need a specific target price, a specific window, a catalyst, and a setup where the near-term risk-reward is genuinely skewed in your favor. The position is fully exposed to market beta, to sector beta, to factor moves, and to the reality that you can be right on the company and still lose money because the market rallied around the position. A short on a stock in isolation makes money if the stock falls. It loses money if the broader market rallies hard enough to lift the stock with it, even if the underlying thesis is playing out quarter by quarter.

A paired short is structurally different. The short is one leg of a relative trade, where you are simultaneously long another name in the same sector, factor bucket, or thematic basket. The point of the structure is to neutralize everything you do not have an opinion on so that the only exposure left is the variant perception you actually believe in. If you are long Lumentum and short Coherent, you are not betting on optics going down or up. You are betting that Lumentum outperforms Coherent. The sector beta cancels out. The factor exposures largely cancel out. What remains is your specific view on the relative quality of the two businesses, the relative defensibility of their positions in CPO, or whatever the variant perception happens to be.

The reason this matters is that paired shorts dramatically relax the surgical entry requirements that unpaired shorts demand. You no longer need the name to fall in absolute terms. You only need it to fall relative to the long leg. Path dependency is partially neutralized because both legs are riding the same market and sector waves. Timing pressure is reduced because borrow costs on a paired trade are partially offset by the carry on the long leg, and the position can sit through broad rallies and selloffs without forcing a cover. Catalysts can be longer-dated because the structure is not bleeding you out the way an unpaired short does. The thesis can be more about durable structural divergence than about a near-term price move.

The technical concept that formalizes all of this is basis risk, which is the risk that your longs and your shorts are not correlated in the way the structure assumes. Gavin Baker described it cleanly: if you are running a high-gross book, the single most important thing to manage is the correlation between your long and short legs. If you are long growth and short value, you are not running a hedge fund, you are running levered growth with extra steps and extra borrow cost. Same in reverse. The whole point of pairing is to generate long-short spread between names that are quantitatively and fundamentally similar enough that the factor exposures cancel, leaving only the alpha you actually have a view on. Pair a great semicap name against a weak semicap name and you have a real trade. Pair a great semicap name against a weak consumer staple and you do not have a hedge, you have two uncorrelated bets sharing a P&L statement.

This is also what makes high gross exposure possible at all. A book with low basis risk can be levered up because the gross exposure is not actually carrying the factor risk it appears to be carrying on paper. A book with high basis risk, levered up to the same gross, is just a directional bet wearing a hedge fund costume, and it will eventually get exposed by a factor rotation that moves the longs and shorts in opposite directions to the structure. The Sharpe ratio that hedge funds are paid to deliver comes from the spread between fundamentally similar names, not from the gross number itself.

This explains why long-short funds run their books the way they do, and why a pure short seller looks like a different animal. A long-short fund is mostly running paired or basket trades where the gross exposure is high but the net is moderate, and the discipline is in matching the long and short legs tightly enough that basis risk stays contained. A dedicated short seller does not have that luxury and has to take unpaired bets, which is why the dedicated short profession is so small, so demanding, and so difficult to do well over a full cycle.

The taxonomy has direct implications for what counts as a good entry on each side. An unpaired short demands the surgical setup described earlier, with target price, target date, and catalyst. A paired short demands a different question entirely, which is whether the relative valuation, relative quality, or relative trajectory of the two names is mispriced, and whether the pairing is tight enough on factor exposure to actually isolate that variant perception. The paired short can be entered on much weaker absolute setups because the structure is doing the work that the entry would otherwise have to do. What you give up is the convexity of an outright winner. A paired short caps your upside at the spread between the two legs, which is usually much smaller than the absolute move on a clean unpaired bet that works.

So when a short investor says they are short something, the next question worth asking is what it is paired against, if anything, and how tight the basis is between the two legs. The same nominal position can be a high-conviction surgical bet, a sector-neutral relative trade, or a factor hedge inside a basket, and the appropriate analysis changes completely depending on which one it is.

My Thoughts on AI Disruption Shorts

So you might have read my recent articles on AI disruption shorts from AI with Jason. Turns out I am actually not short any of them right now. Or well I was short but decided to exit. Doesn’t mean I don’t like the thesis — I just don’t like the trade.

The reason traces directly to everything in the previous sections. A good thesis is a prerequisite for a short, not a trigger. The trigger is the stock reaching a price and setup where the near-term risk-reward is favorable, and right now none of these names clear that bar.

Software has already compressed. The names trade at multiples that reflect a meaningful amount of the disruption thesis. HUBS, MNDY, ASAN are all well off their highs and trade at valuations where the bar to surprise to the downside is much higher than it was eighteen months ago. The pure path-dependent question of “how much room is there to fall versus rally from here” no longer skews in my favor on most of these.

Staffing and labor pass-through is in a cyclical trough. RHI revenue went from $6.4B in 2023 to $5.5B TTM. The comps over the next few quarters get progressively easier. The cycle bull case is that hiring resumes, comps flip positive, and the stock rallies on what looks like a recovery, even if the structural AI thesis is grinding away in the background. Shorting into easy comps with depressed valuations and a potential cycle turn is exactly the setup where the path can kill you for a year or two before the destination eventually arrives. The thesis can be right and the trade still loses meaningfully.

The deeper problem is that AI adoption, while genuinely fast in absolute terms, is still too small a share of revenue at any of the target companies to move near-term numbers in a way the market will price as a structural break. Cognition is replacing some functions at some clients, but not yet at a scale that shows up cleanly in next quarter’s guide. Without that kind of catalyst, the disruption thesis stays in the slow-moving structural bucket, and slow-moving structural shorts are the worst kind. They have all the carry cost and squeeze risk of a regular short with none of the near-term resolution that justifies the position.

So the entire basket sits on the watchlist, fully developed and ready to deploy, and not a dollar of capital is committed to any of it. This is the discipline that the good short investor I talked to embodies. He keeps forty live theses on the page and is short almost none of them at any given time. The thesis work is permanent infrastructure. The trades come and go based on what the price action gives you.

What would change my mind is a macro environment where the index’s risk-reward inverts. Right now the broader market still has more upside than downside on most reasonable forward looks, which means individual shorts are fighting a tailwind on top of all the other structural headwinds discussed in earlier sections. In an economic boom that pushes valuations to a point where the macro skew flips, where downside on the index becomes more likely than upside, the entire calculus changes. At that point staffing into the late-cycle peak with hiring rolling over, software priced for permanence in a multiple compression environment, and consumer intermediation in a discretionary slowdown all become trades where the path is finally working with the thesis instead of against it. The basket gets deployed not because any single thesis got better, but because the price and the macro setup finally caught up to the work.

This is the right mental model for the basket. The research was not wasted by not putting on the trades. It was the prerequisite for being able to act quickly when the entries actually appear. The mistake would have been doing the work, getting attached to the thesis, and shorting into a setup where the path was going to punish me regardless of how correct the destination ended up being.

Why I Am a (Mostly) Long-Only Investor

Two simple reasons

First, my disposition skews long. I’m a big picture, first-principles, long-term thinker and not a detail oriented, analytical, short-term one. This fits longs far better than shorts given our framework.

Second, the economics of shorting for retail investors don’t make sense. You cannot pay your bills with Sharpe ratios. Being correlated to the index is fine. In fact for someone trying to grow capital meaningfully from a small base, correlation to the index is closer to a feature than a bug, because the index has a structural upward drift that you are trying to ride and outperform, not neutralize. The whole point of running a hedged book is to deliver risk-adjusted returns to investors who care about volatility. If you are managing your own money and the goal is absolute compounding, the volatility of being net long is the price you pay for the returns you are after, and trying to hedge it away is just throwing returns away.

Third, the payoff of an hour of analysis on a long is much better than for a short. Twenty hours of work on a short might, if everything goes right, deliver a 30 percent return on the position over a six-to-twelve-month window, and most of that return comes back to you in price action that is hard to capture cleanly because of the path issues already discussed. The same twenty hours spent on a long can identify a multibagger that returns 100 to 300 percent over a few years, with no carry, no squeeze risk, no forced cover, and the option to add to it if the price moves against you in the meantime. The dollar return per hour of analytical effort is not close. And because the long return is uncapped while the short return is capped at 100 percent, the upside distribution is fundamentally different. Spending the scarce resource of research time on the side with the worse risk-reward, the worse path properties, and the lower per-hour expected return is not a defensible allocation of effort for someone in my position.

In conclusion, it is my opinion (not financial advice) that retail investors should (usually) never short.