What you are describing is a lower-risk strategy, but it has a lower payoff as well. If one is very sure that a stock is overvalued, shorting is the best (simple) strategy to profit from it; if one is less certain, your strategy is a good one.
What if you are very sure that a stock is overvalued, but totally unsure where it will peak first? Shorting it could leave you in real trouble then, even if you can somehow be totally certain that you're right about where the price will eventually be.
I was talking about the S&P500, which is composed of a few hundred different companies, so the risk of one company hurting you is low. You are right about the risk of shorting, but it is the strongest bet you can make. I would probably take out a put option on an S&P500 ETF if I agreed with the post I initially responded to. By buying the S&P501-750, you would also be fairly well secured against market upside risk.
My first response was intended more as a rhetorical question asking whether the poster is actually willing to bet money on their idea. I never really meant to enter into a discussion on the pros and cons of various trading strategies.
Even the S&P 500 could keep on going up a long way despite eventually being doomed to drop substantially. (I have no idea if it actually is, of course.)
My point is just that seeing if someone is putting money behind their opinions about the long term isn't really telling, because "markets can remain irrational longer than you can remain solvent" and you may not know just how long term it'll be.
In addition to the margin call concern, just because a stock is overvalued doesn't mean it will reach its fair value before an adverse event (let's say the company makes a gamble with positive expectation, but it doesn't work out) happens that lowers its fair value. If that were to happen, he could be a few hundreds of millions in debt.
>"In addition to the margin call concern, just because a stock is overvalued doesn't mean it will reach its fair value before an adverse event (let's say the company makes a gamble with positive expectation, but it doesn't work out) happens that lowers its fair value. "
I'll assume that you meant the opposite of this quote (, that the stocks being short-sold beat expectations, and their fair value went up,) as what you said would benefit the short seller.
You are right that the stock could take longer than expected to reach its eventual (lower) value, but this is why you would bet on a large number of stocks (i.e. S&P500), to reduce the risk of a single or few adverse events cancelling out the strategy. In addition, by purchasing the S&P501-750, with the money from short-selling, you would be fairly well protected against market upside risk (as it is unlikely that the S&P500 will be the only stocks to do well in a bull market). You could also purchase options to reduce the risk of the short, but a (simpler) alternative would be to take out a put option on the S&P500, which the better believes will go down; this is obviously somewhere between the portfolio bias approach, and the short approach in terms of risk (and reward if you believe in EMH).
