Lessons In Short Selling From The Master Short Seller Jim Chanos Himself

Founder of Kynikos Associates and arguably the best short seller of our times, Jim Chanos, was on Wall Street Week this Sunday to provide his insights on short selling as an investment strategy and to reveal how he manages risk while he is short on a stock.

Why Short Selling?

“Short selling occurs all day in commerce in everyday life,” Chanos said. “Anybody that receives cash up-front for delivering goods or services in the future is engaged in short selling. So, if you think about lot of businesses that we hold near and dear in part our everyday lives, they are short selling schemes. Insurance is a giant short selling scheme.”

“Insurance companies collect premium upfront, they analyze your lifespan or the risk of your house burning down and will pay out if those things happen. More importantly in the financial markets, Bill Sharp the famous financial economist in his Nobel Prize winning speech pointed out that efficient market theory in Capital Asset Pricing Model (CAPM) are dependent upon frictional short selling.”

He continued, “And what he meant by that was that people who don’t already have a position or a viewpoint on an asset have to be able to affect pricing if they so choose. So, if they think something is too expensive, they have the ability to sell that service in exchange for providing it later and you need them as economic agents to actually set pricing.

Managing Risks

Chanos was asked how he manages risks when he enters a short position. He replied, “When you short a stock, it can go up to infinitely, it can only go to zero, but I have seen far more stocks go to zero than infinity. So, what you have to do as any portfolio manager has to do in a construct of a portfolio is simply set capital limits on each position.”