What I Learned From My Tesla Short Carnage

Summary

• If you ever happen to short growth stocks, be very strict about your stop-loss limit.
• Many factors came together in 2020 that moved Tesla's stock substantially.
• I still remain bearish, but advise against initiating a short position in Tesla.

Photo by Sjo/iStock Unreleased via Getty Images

As an investor, you are permanently exposed to the danger of losing your invested money. Selling stocks short brings new challenges in the form of potentially losing more than you invested. Even if your short idea turns out to be correct in the long term, you are vulnerable to bleeding out before your trade proves you right. Shorting stocks is thus dangerous since it requires you to time as well as to pick correctly. That asymmetric risk must not be underestimated prior to initiating a short position.

As an extreme cautious tale about short-selling, take for example the case of Wirecard AG (OTC:WRCDF, OTCPK:WCAGY) from Germany. A very reputable newspaper, the Financial Times, made serious fraud allegations about Wirecard as early as 2015. The company went bankrupt only in June 2020 after in the meantime rising four-fold and reaching its peak in summer 2018. The initial allegations by the Financial Times all turned out to be spot on.

That was an extreme case of fraudulent conduct which only relates to the main topic today in pointing out the dangers of selling stocks short.

I have lost a lot of my own money shorting Tesla (TSLA) stock last year in the midst of its strongest bull run. The fact that not all of it is yet realized does not make it better. The silver lining is that I am much richer in life and investing experience, even though nothing I learned, was completely new to me. It is just that when you learn something while feeling intense emotions, the material sticks in your brain a lot better. Let me share my experience with you, so hopefully, you can benefit from my experience.

I took a short position in Tesla last year before the stock split was announced. After it rose, I doubled my position. After the stock climbed steadily and in bursts of sudden upward moves, I hesitated to close out the position and the situation got worse after each latest news catalyst. On top of that, the macro-economic circumstances tied to the global pandemic propelled growth stocks and some particular industries, like electric vehicle, biotech, and technology. In the case of Tesla's magnificent bull run last year, many influencing factors played in favour of Tesla and against its short sellers.

Allow me to list the lessons I have learned the hard way in the hope you might avoid them and be more prudent.

Short-term trading positions are left in the portfolio to reach break-even

You initiate a short-term trade because you think you know what is going to happen next. The trade moves against you and you then hesitate to close because you think that in the coming days/weeks it will go back to where you expected it. The market will come to your reasoning and you will recover the loss. Once the time passes by, the stock moves against you even more. Your hesitation becomes stronger because you need to make up a larger amount now to realize even a slight loss. Some investors and traders, then move that stock to their long-term portfolio after they gave up the hope it would recover in a few days. I guess, this scenario or with some slight variations happened to a lot of us.

The asymmetry of a 50% percent loss in stock, and the subsequent recovery of 100% needed, for you to be at break-even, is a known relation to any stock trader and investor. This is another topic.

My point here is of a different nature: when you do short-term trading, you believe you have an edge for one specific stock of say 60%. So, you are slightly better than flipping a coin. But you must know that your edge works only after you repeat the experiment a couple of times, not to say a couple of hundred times. Once you see, the trade is running against you, you must close after a pre-set threshold is reached. Otherwise, one bad trade can ruin all your excellent work.

News cycles can wreak havoc on your losing trades

I always thought, once a growth stock is overvalued as Tesla was at a price-to-sales ratio above 15, all the good scenarios are already priced in. So, once news about what was already contained in the best-case scenario gets in, it should not move the stock more to the upside. What fatal thinking that was. Newly arriving pieces of news can move the stock up further, which again creates momentum and that again creates some news of the kind "stock X moved by y% in the previous weeks/days."

Wall Street analysts revise their price targets, only based on recent upward moves, not based on fundamentals. That brings in new short-term traders who think it can only go up from there. These cycles, if repeated a few times, can significantly diminish your savings or portfolio gains.

Shorting stocks as a hedge for your portfolio

Well, this one is tricky. It can work for a long time, just until the day it does not work anymore. Hedging works either through options which if done properly ensures that in certain price scenarios you can still buy or sell a stock or hedging works through mutual correlations between stocks or sectors. The classical example is to go long Mastercard and short Visa. The same way you can have a certain portfolio and say as a hedge you go short Apple or Tesla. So, when the markets go up you will profit from your portfolio and have a (hopefully small) loss on your short position. If the markets go down, you lose on your portfolio, but you will have some offset gains on your short positions.

The problem with hedging based on correlations is two-fold. Correlations are based on historical data, so the first question is how long do you go back to calculate the correlations? Secondly, correlations are only linear dependencies. And, thirdly, an existing, strong, and linear relationship might cease to be valid going forward because something drastically changed for one or the other stock. The latter exactly happened with my Tesla short. I initially bought it as a market downfall hedge. In the end, it turned out as a double-edged sword, because all my cyclicals were falling, and Tesla stock was rising. I did not have any growth stocks to alleviate the 2020 lockdown market sentiment.

Doubling down your position to increase the selling price

This is also a dangerous and very common one. To double down on your position when you intend to take a long-term position in a company is legit and I have done so many profitable trades with this strategy. The danger comes from applying this strategy to your short-term gambles that turned out to be unprofitable in the short term and it is related to the first point I mentioned: converting your short-term gamble into a long-term position. Well, do not double down on short-term positions. Especially, be clear before each trade which sort it is and then based on that initial decision, make restrictions if you can double down or not.

Shorting (growth) stocks because they are overvalued

Coming from the school of value investing and The Intelligent Investor (the initial book on value investing from Benjamin Graham) you might be tempted to look at valuations of some company and ask yourself doubtfully if you are missing anything or if it is just another market frenzy. You might wonder how a growth trajectory should look like to justify a certain price-to-sales or price-to-earnings ratio. The larger problem is that it can trade at elevated levels for an exceptionally long time. Another cautious tale is that it can even trade way higher than those initially high perceived levels.

In the same way, markets, as well as individual stocks, do not reverse to bear markets just because they are overvalued. They usually start a downfall upon certain unexpected catalysts or outside events. This could have been witnessed on the market level recently once the ten-year U.S. Treasuries reached 1.6% and 1.7%, coming from below 1% levels from last year.

The doom-laden articles you can read on the web do not give you necessarily a useful actionable insight, besides informing you how much the market currently is beyond historical territory. The market can go up another x% from that point and that period can take another few years until some catalyst emerges and breaks a long bull market. Take, for example, the Nikkei in the 1980s:

According to this paper, published in the Journal of Financial Economics, the price-earnings ratio of all Nikkei listed companies increased from 37.9 to 70.9 between 1984 and 1989. By the reasoning of most (value) investors, 37.9 is already very elevated. But, as you see, it still went up substantially. For reference, according to WSJ, the trailing 12 months P/E ratio for the NASDAQ 100 Index was 37 as of 12th March 2021 with a forward twelve-month P/E ratio of 28 (see the next figure).

A famous saying by John Maynard Keynes goes "Markets can remain irrational a lot longer than you and I can remain solvent." (from A. Gary Shilling, Forbes (1993) v. 151, iss. 4, p. 236)

Do not bet against a storytelling stock

Storytelling stocks are extremely hard to bet against. This is especially the case if there is a large follower base that blindly believes everything, they hear from a CEO turned Messiah. It is hard to trade against a fan base that does no contemplation about the uttered (tweeted) statements by the Messiah, nor about the inherent uncertainties or about the likelihood of said events to occur.

When Tesla's CEO tweets that the company is going to sell 20 million cars by 2027 or by 2030, that just becomes a catalyst for a new market high, without the buyers thinking critically about the likelihood of it actually happening. The fan base does not waste a thought on EV demand by 2027, nor the stress on electricity grids, nor the supply of lithium for such a high number of batteries. I recommend this SA article by the Kovacs brothers about the supply of silver, indium, and lithium. Then the media cycle as mentioned above starts again. Experienced investors then recognize the momentum, which adds further to the buy-side. Then a short squeeze of short-sellers might happen, which again turns the wheel from the beginning.

The point I want to make clear here is that once many small events happen to coincide and the formed snowball starts rolling downhill, it can easily become a self-feeding machine that turns into a large avalanche and gets out of control. That can happen with other stocks on a different scale. Not much is needed usually to get that snowball rolling downhill. Take the trend of green hydrogen recently that propelled Plug Power (PLUG) to some unjustifiable highs. Or the data science and data handling fantasies that propelled Palantir (PLTR) to the recent highs.

Before you discard my article as just another value investor only looking for low P/E ratios, stable cash flow, etc., let me tell you, I understand and accept the notion of growth stocks. At some point in the life cycle of a company, a growth stock becomes very large, so it is impossible to grow by the initial large growth rate and to keep on trading at elevated price-to-sales and P/E ratios. One sort of exception here is Amazon (AMZN), which managed with AWS to turn a whole new business segment into a growth machine. Thus, they were able to maintain an elevated P/E ratio over the previous years, even after having existed for over 26 years now, with 24 years of being a public company.

Data by YCharts

Also, the notion of being a growth stock does not mean it can swallow all kinds of fantasies about growth and market penetration with complete disregard of future competition.

Asymmetric incentives for institutional investors

Once, a trade gets all the attention, institutional investors slide into a dilemma and their motivation and incentives work in favour of buying a fashionable stock, even if they are aware of its overvalued status. They have a low incentive to short the market or a specific stock. So, when you are shorting a specific stock, the group from which you will be getting the least tailwinds is the group of institutional investors.

Their decision making looks like this in a bull market:

Action	Market Scenario	Consequence
long stocks	bull market prevails	(small) hero, big bonus, momentum on his side
long stocks	bull market reverses to bear market	no hero, but no job loss
short stocks	bull market prevails	looks like an idiot; loses his job
short stocks	bear market	hero, big bonus, momentum working against him

Click to enlarge

Short squeezes are like a fire in the forest for short-sellers

This lesson could have been taken with improved live events unfolding more recently with the whole GameStop and AMC Entertainment trades. I will not go into more details about this topic because it just happened a few weeks ago and is still fresh in everyone's minds. The take-home message here is to know how dangerous short squeezes can be for a short seller.

The outlook for Tesla

Tesla has done an outstanding job in moving companies into EV production and potentially bringing great environmental benefits to the world. Its cars are high-end, premium quality cars. But and these are some large "buts": car making is a highly competitive industry, where lots of established players will soon catch up, where lots of new Chinese EV start-ups have risen to prominence. Many will not create cars with quality at par with Tesla, but they will eat a large chunk of its cake because these other cars will fill market niches and demand that Tesla physically cannot cover. Margins in the automotive sector are known to be 10% at best for premium brands. Tesla without the regulatory credits for last year, would not have been a profitable company in 2020.

Ask yourself if you consider investing long-term in Tesla: do you want to pay $600B for a company that might or might not earn one to two billion dollars in 2021. Even when Tesla reaches $100B in revenue and with an EBIT margin of 10%, their EBIT will be somewhere at $10B. I remind you, the company's revenue in 2020 was at $31B. How many years are needed to reach $100B? How will the EV market look at that time? Fundamentals will matter sooner or later. It is hard to keep a hype going for so long on Wall Street.

To short-term traders, I am wishing you good luck and sending a piece of advice to stick to your risk management principles.

(Source: Twitter; Tesla's CEO had his word on the company's valuation back on May 1, 2020, when Tesla stock was trading at $150 levels)

I remain bearish, but I strongly advise against selling Tesla short. The piece of advice is to those with less short-selling experience and with problems complying with their own risk guidelines. The reasons were elaborated above, but I would like to cite one last reason: if nothing else, then for the sake of your mental health since the volatility can damage your nerves.

Analyst’s Disclosure: I am/we are short TSLA, NIO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[Bearer of Bad Tidings]

A good article overall. Points to you for admitting the personal risks of short selling. I've only a small portfolio, rarely shorting directly, instead wagering (usually losing 🤓 ) with SQQQ or a similar inverse ETF.
You calling Financial Times "very reputable newspaper" gives me pause 🧐.
Having something of a wiseass tendancy, I refer to them "People Magazine for the Davos set doing business as ft.com"; doubtlessly I appropriated that epithet from elsewhere. I do check them every few days. I can't comment on their business coverage; perhaps it was better six years ago. But it's clear their political, social and ecoomic coverage is Woke-Liberal-Left. Of course, they're far from the only periodical that has shifted ideologically. I subscribed to The Economist for years but dropped it for that reason. Of couse, that is OK, freedom of speech and all that. It's almost inevitable that such groupthing will color their investment counsel (e.g. Green energy vs. fossil fuels, allegations of slave labor in China, etc.) By no means do I claim that ZeroHedge or Breitbart will do any better 🤣 . The point is take anything you read with a grain, sometimes a whole shaker, of salt.

[Mirsad Tulic]

@Bearer of Bad Tidings thanks for your original comment regarding ft and economist. Regarding ft: I cannot judge about their political and social articles lately. but I can tell you that in the case of Wirecard they were the first and only ones to break the story with proper research. a team went over to Asia back then and checked the paper companies Wirecard claimed to make business with etc.
The author got threatened (if I remember correctly, even by some state authorities). they repeated their claim in 2018 when stock was trading at all-time highs. so kudos to that indeed. They have proper journalists and are not copying ideas from others.
your point to take everything with a grain or shakes of salt, totally true indeed. Especially, considering we can never know someone's full motivation and intent for writing some article or some statements.

[FlagFootballSaint]

As others pointed out Musks quote was most likely related to his idea to split the stock, not a reference to the valuation

Anyway:
They split the stock and the rest goes down in history books

[Calvijn]

Excellent personal experience article. There is a place for shorting in the market-lots of irrational criticism here. Guess that is why markets aren’t entirely rational. Well done.

[hi.jasti]

You sound like it is 2031 or 2035 and Tesla didn't even close to mentioned target. One thing we should learn from this writer is "Don't be too confident about anything". There is always something which you don't know. Writer should have complete this article in three words "Don't short stocks". Stocks always goes very high when goes up and vise versa. What about Netflix?. When stock goes below 40(200 before split), Was fanbase wasn't there?

[minhongz]

"The silver lining is that I am much richer in life and investing experience, even though nothing I learned, was completely new to me." Lol, another way of saying "I am stubborn as hell and will never learn"?

[Apple Dan]

@minhongz
No, it sounds from the tone of his article that he came out the exact opposite of what you said. He acknowledged certain mistakes and seems to be seeking to avoid a repeat.

[Actionable Conclusion]

I see it in the middle. He learned half the lesson. I wonder if he will learn the other half. Maybe he did but did not want to admit it?

Anyway, the important thing is to exit shorts quickly if they are moving heavy against you. Especially if you're shorting extremely dynamic companies. And especially if you're shorting fast growing industries. And exit he did :-)

[Majky]

Its funny how everyone hate tesla and write about valuation. I know valuation of Tesla is high, but there are plenty other stocks more overvalued which are even recommended to buy from analysts. I wouldnt buy tesla at these levels, but why I should short it, there are plenty other stocks which are great to invest. Just avoid TSLA and dont uselessly risk...

[Fortunate Islands]

@Majky 100% right. Tesla is so much under scrutiny that it's very dangerous yet to play with its stock. There are indeed so many other promising companies and less volatile opportunities. Better keep away from Tesla, neither short nor long.

[johnnygibber]

Excellent timing for reading this. Started ETC short on Tesla 23rd Feb. breaking ~ even. I think mr burry is correct on TSLA. here in Germany EV market not in going in Tesla‘s favour. Maybe Berlin giga factory will make me cry in my pils.

[mlhutche]

@johnnygibber You can post this after seeing the Q1 sales results? Getauscht.

[johnnygibber]

@mlhutche yeah fair point. Short term voting machine, Long Term... who knows eh ?

[FreedomOfTruth]

If you think Tesla is merely an automotive company then your premise for investing in it (in any manner of investing) is incorrect.

[Apple Dan]

@FreedomOfTruth
Whatever, that is crap and it shows you have never looked at a Tesla 10-K.

[meyerpaulr]

When Tesla finally reaches a reasonable price, we will know, like Elon said, that “at least the crater is in the right place.”

[Dubious Brother 2]

I take exception to your statement: "Tesla has done an outstanding job in moving companies into EV production and potentially bringing great environmental benefits to the world." It is government edicts that have moved companies into EV production and not Tesla. Without those government edicts and incentives the other car companies would not be forced into the unproven EV market. As far as great environmental benefits are concerned, time will tell but it is never as awesome as those that are profiting from the changes make it out to be.

[mlhutche]

@Dubious Brother 2 Certainly subsidies are the biggest push or we'd be decades slower, but no question Tesla accelerated it by several years by: developing compelling vehicles, the Supercharger system, and showing the path to dramatically lower costs and real profitability that can eliminate the need for subsidies in just a few more years even for the late-comers.

[goadamgo]

If you think a stock like Tesla is too expensive to buy in, then sell short dated otm puts. Enjoy the momo.

[Fortunate Islands]

Hello Mirsad,
What a pleasure to read an article from someone recognizing he is not a genius of investment, and not claiming he is the next market wizard, as many SA's articles authors tend to do! With your humble attitude, you look to me as a smart and intelligent person, and I strongly encourage you to continue learning and developing your financial knowledge. I really advocate you read the Alchemy of Finance from George Soros, as it explains irrational exuberance, and also you may study a few articles on behavioural finance.

Most senior investors with a long experience are saying that shorting stocks is much harder as just being long. Also, your gain on a long position is unlimited and can reach as much as 10 folds your purchase price while it is capped by the purchase price on any plain short trade strategy!

I would never short Tesla as their CEO did not hesitate to post a tweet with a strong upside immediate effect, even if the proposal did not come true (see the tweet in August 2018 about taking Tesla private at $420 a share).
Best regards

[olsaki]

Excellent article, great advice. Even if there are many points that should be well known to most investors, these are often forgotten after the focus on one's own narrative has become too narrow. Since I am a paper type, I have printed it out and put it in my first drawer in order to remind myself of the truths it contains from time to time.

Life is a journey. What are your accounts worth on the day you die if the rewarding experience of learning was missing on this journey.

[r Negoro]

Bro never short cult stock. You see people all over worshipping Elon as the tech prophet, wouldn’t be surprised if it goes up to $3000.

[Kevoo]

Shorting Tesla is just plain stupid, lots of folks like this one have been on that road and many are still in denial. Don't do it lads. Save your money.

[jz10]

Shorting based on valuation alone is extremely dangerous, since you run massive liquidity risk.

You absolutely have to incorporate technical analysis for successful shorts. Momentum is an extremely powerful factor, because of its balance sheet effect on the investor population.

Think of it this way, as TSLA moves up, the TSLA longs have more and more equity. The most die hard Tesla bulls gain the most, and in a market place where your vote is weighted by how many $s you have, they are gaining vote share over everyone else. Conversely, Tesla bears get killed and their voting weight becomes miniscule.

In the short run you will get run over if you try to fight this dynamic. The important thing is to never try to short at tops, because you have no idea where the top is for a stock that is way overvalued. The time to go short is when momentum turns. At some point even the bulls think the stock is overvalued and start cashing out. The new buyers are dumb momentum chasers. Once enough bulls start cashing out, momentum stalls and the balance sheet effect starts reversing.

You should not increase shorts on the way up, but on the way down.

[imeldo marcos]

@jz10 good point bro. Looking at how tesla rebounding from $550,, momentum is still up.

[Mirsad Tulic]

@jz10 Thanks, mate for this comment. This is very much appreciated and I hope many will read this comment carefully.
I have learned that as well, but unfortunately, that lesson was learned during my carnage as well, so next time I will know better.

[jz10]

@Mirsad Tulic yeah, I hear you. I too learned this lesson by losing money. It's a very hard learned lesson that is very hard to appreciate until you have actually shorted and lost. It is easy to think that you will be eventually proven right and ignore the balance sheet effect on your staying power and psychology until you have experienced it first hand.

[JoeD23]

Shorted tesla at 810 based on advanced TA. Bought a Tesla Model S with the profits. Be like me

[Bearer of Bad Tidings]

@JoeD23
I like the way you think. But I would instead have bought a well-used BMW 700-series and kept the difference for the upkeep. Same lousy depreciation as an EV, so let someone else pay it.

[JoeD23]

@Bearer of Bad Tidings Still short, bought both

[Z-alpha Trading System]

The mere fact that most people don't want to short TSLA is the exact reason why it's an outstanding candidate for shorting. The stock's price action structure is noticeably institutional, making price exhaustion and minor price reversal setups quite recognizable. The two mistakes investors & traders habitually make with short selling are position size error and the position-time metrics. TSLA has defined volatility by are standards, liquidity, all-important institutional participation, gap characteristics, market profile quant levels, and a host of other advantageous and essential qualities. The machines have puppy love with this stock for its retracements, as would we if we were in the shorting business.

We hope this adds value.

[HPBunker]

@Z-alpha Trading System

"The stock's price action structure is noticeably institutional"

Could you elaborate on this? What about TSLA's price action structure is noticeably institutional? Why is it better to short a stock with greater institutional participation?

[Booba]

Hmmmm.... Plug Power or Palantir, all the same? Ok, I'm not an expert, so let's see what expert say. Just a quick googling result.
Plug Power
"For the next two years, the company won't be profitable. There is no basis in logic why Plug Power should have a $14.7 billion valuation when net income will be -$63.4 million in 2022. Dec 31, 2020, Yahoo Finance
Palantir
"Palantir's revenue rose 25% to $743 million for the full year in 2019. But in the first nine months of 2020, its revenue rose 50% year over year to $771 million. During that period, 55% of its revenue came from Gotham, its platform for government agencies. ... Palantir's revenue from Foundry rose 30% year over year" .Dec 2, 2020 Fool.com
It appears, those two companies are not that similar, aren't they?
BTW, Plug Power is largest holding of Vanguard Small-Cap Growth Index Fund ETF Shares.... This is major reason I didn't buy this ETF.

[imeldo marcos]

@Booba pltr can grow very well if it can streamline its products.

[Joshua Lung]

Of all the bearish articles I read on Tesla, the only reasons given for their bearishness is overvaluation and coming competition.
However, the bulls have very in depth analysis on why Tesla has achieved huge economic and competitive moats against the competition and the multiple new business segments that Tesla is building aggressively.
The bears understanding of Tsla pales in comparison to the bulls.
Buffet advocated never to invest in what you don't understand.
I think value investors keep making that mistake. Trying to value something they don't understand.