The mathematics of shorting is not fair. And this is a serious issue.

Let’s say with all things being equal you decide to go long and short a 100 USD stock for a period of one year, and your starting capital is 100 USD. In each case we will calculate the gains or losses of each position with a movement of 10 USD. For calculation purposes the interest rate would be libor which will be 4%. If you are borrowing money it would cost you 4.5%, and if you want interest you will get 3.5%.

The table of returns are as follows:

  Gain 10 USD Loss 10 USD
Long 110 90
Short 115 95.5

If you look at my table you will say, "hey Christian you are wrong, how can your short losses be less than the long."

Well, here are the numbers.

If I go long with a 100 USD, I am loosing the ability to collect interest on my 100 USD. When I short a stock I don’t loose that ability. When I short a stock I get to keep my 100 USD. Though what I have to pay are the borrowing costs, which I have set to 2%. On top of it by going short you can collect the interest of not 100 USD, but 200 USD (100 USD money + 100 USD you get from selling a share).

Thus by shorting you have an uneven advantage, and because your money is getting interest your can outlast the long with all things being equal.

Add on my psychological aspect and you have some serious issues on why shorting a stock is more problematic for the market than going long.

Some of you might say, "hey how come I don’t get any of this? Because your broker keeps the money!"

For some brokers, the short seller may not earn interest on the proceeds of the short sale or use it to reduce outstanding margin debt. These brokers may not pass this benefit on to the retail client unless the client is very large. This means an individual short-selling $1000 of stock will lose the interest to be earned on the $1000 cash balance in his or her account.

Your broker charges you money, they earn interest, and you take the gains or losses…

In other words shorting makes more financial sense than going long! That’s why we need special rules for shorting.