= 27d567bc2d48d9f40e9ccc20ea370b15)
Lumifer comments on Stupid Questions, December 2015 - Less Wrong
You are viewing a comment permalink. View the original post to see all comments and the full post content.
= 783df68a0f980790206b9ea87794c5b6)
Loading…= b715d02e85f7b3b4ae65ca3d3e450868)
Subscribe to RSS Feed
Powered by Reddit
= f037147d6e6c911a85753b9abdedda8d)
You are viewing a comment permalink. View the original post to see all comments and the full post content.
Comments (138)
Repeating my question from late in the previous thread:
It seems to me that if you buy a stock, you could come out arbitrarily well-off, but your losses are limited to the amount you put in. But if you short, your payoffs are limited to the current price, and your losses could be arbitrarily big, until you run out of money.
Is this accurate? If so, it feels like an important asymmetry that I haven't absorbed from the "stock markets 101" type things that I've occasionally read. What effects does it have on markets, if any? (Running my mouth off, I'd speculate that it makes people less inclined to bet on a bubble popping, which in turn would prolong bubbles.) Are there symmetrical ways to bet a stock will rise/fall?
This is accurate.
This asymmetry comes from the fact that prices are non-negative numbers and do not dip below zero.
Effect on the market? Off the top of my head, here is a couple: long-term shorts are more risky than they seem; and shorting penny stocks (stocks with a low price, typically below $5) is also "extra" risky because your upside is small, but your downside is not.
The fact that shorting penny stocks is dangerous isn't because of their price per se, it's because they are typically much smaller companies than normal stocks. That means their profits and prices are much more unstable, so are much more likely to double in value in a short period of time than, say, British Petroleum. Also, because they are so small, much smaller amounts of money can change the price of the stock, which makes them more prone to market manipulation or investor exuberance (this is a non-linear effect, some stocks are so thinly traded that just a couple of trades might happen per month, and whichever is last sets the price for it). Even if a penny stock did a reverse split that made their shares $100 each, they would still be just as risky for these reasons. Also, because penny stocks are thinly traded, stops are much less effective for short sellers.
You are talking about why penny stocks are volatile and yes, that's all true. However it's also true that the upside/downside asymmetry is especially pronounced for them.
I'm confused. Do you believe that if you took a penny stock and divided its share count by 100, thus multiplying its price by 100, it would be less risky for short sellers simply because of the price? Let's assume for the sake of argument that it's current price is in the $3 range, so the fact that the minimum quote is in pennies isn't a large effect.
Hm, I think you're right. The high(er) risk for shorts is a function of volatility (or, more generally, distribution shape) and not of the price level.
The price level has its consequences but these tend to be beneficial for shorts.