Short Selling Does Not Work

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There is an interesting discussion on short strategies going on currently and here is one traders quantitative observation.

Assuming that a trend-follower has the ability to short stocks as well, survivorship bias would imply higher returns in live trading compared to back-test (probably higher risk-adjusted returns as well).


This is true. But, this is usually nullified (for most people) because they are backtesting on data that has not been adjusted for cash dividends (which overstates the profitability of short selling).

We spent a long time trying to come up with ways to short stocks profitably. We couldn't come up with anything that worked over long stretches of time (>10 years) nor could we come up with a fundamentally sound reason to expect to. Stocks are basically a perpetuity with unlimited upside and guaranteed containment on the downside. Approx 50% of stocks have historically ended their existence with a negative terminal wealth relative, but their potential declines have always been capped at -100%. The other 50% of stocks enjoyed potentially unlimited gains, many exceeding 500%. From a short sellers perspective the math simply doesn't yield a positive expectancy.

The best we could ever come up with was -4% compounded annual return, which is better than -12% one gets from simply shorting the indexes. Still it's hard to get excited about losing less money than something else.