Take the 2-minute tour ×
Personal Finance & Money Stack Exchange is a question and answer site for people who want to be financially literate. It's 100% free, no registration required.

Considering the downward spiral in the market (which many are predicted will continue), I was thinking perhaps selling short would be the right strategy.

But from what I can tell on my brokerage account, they only allow shorting individual stocks (there isn't a bearish mutual fund that I can find, for example), and many columnists treat short selling as a riskier and more "advanced" strategy than the usual buy-and-hold.

Why?

share|improve this question
    
See my answer at this related question: money.stackexchange.com/questions/695/… –  Chris W. Rea Jun 13 '11 at 11:59
2  
In finacial terms, "advanced" or "complicated" translate to high risk. If you are an individual investor and not a speculator, "advanced" also means "stay away". –  duffbeer703 Jun 13 '11 at 16:44
2  
And if you expose a large portion of your portfolio to such risk without diversity, "Advanced" can also mean "get wiped out bigtime' as well –  Chuck van der Linden Jun 15 '11 at 19:46
add comment

3 Answers

up vote 26 down vote accepted

When you short a stock, you can lose an unlimited amount of money if the trade goes against you. If the shorted stock gaps up overnight you can lose more money than you have in your account. The best case is you make 100% if the stock goes to zero. And then you have margin fees on top of that.

With long positions, it's the other way around. Your max loss is 100% and your gains are potentially unlimited.

share|improve this answer
5  
Another risk of shorting is that the broker can just close your position without warning because the borrowed shares had to be given back for whatever reason. And there's the short squeeze, here's the story of a famous one: diyhedgefundsonline.com/2009/01/08/the-short-squeeze-of-death where a stock went up 5x in two days despite the fundamentals. –  Havoc P Jun 14 '11 at 1:54
add comment

In addition to the higher risk as pointed out by @JamesRoth, you also need to consider that there are regulations against 'naked shorting' so you generally need to either own the security, or have someone that is willing to 'loan' the security to you in order to sell short. If you own a stock you are shorting, the IRS could view the transaction as a Sell followed by a buy taking place in a less than 30 day period and you could be subject to wash-sale rules. This added complexity (most often the finding of someone to loan you the security you are shorting) is another reason such trades are considered more advanced.

You should also be aware that there are currently a number of proposals to re-instate the 'uptick rule' or some circuit-breaker variant. Designed to prevent short-sellers from driving down the price of a stock (and conducting 'bear raids etc) the first requires that a stock trade at the same or higher price as prior trades before you can submit a short. In the latter shorting would be prohibited after a stock price had fallen a given percentage in a given amount of time. In either case, should such a rule be (re)established then you could face limitations attempting to execute a short which you would not need to worry about doing simple buys or sells.

As to vehicles that would do this kind of thing (if you are convinced we are in a bear market and willing to take the risk) there are a number of ETF's classified as 'Inverse Exchange Traded Funds (ETF's) for a variety of markets that via various means seek to deliver a return similar to that of 'shorting the market' in question. One such example for a common broad market is ticker SH the ProShares Short S&P500 ETF, which seeks to deliver a return that is the inverse of the S&P500 (and as would be predicted based on the roughly +15% performance of the S&P500 over the last 12 months, SH is down roughly -15% over the same period). The Wikipedia article on inverse ETF's lists a number of other such funds covering various markets.

I think it should be noted that using such a vehicle is a pretty 'aggressive bet' to take in reaction to the belief that a bear market is imminent. A more conservative approach would be to simply take money out of the market and place it in something like CD's or Treasury instruments. In that case, you preserve your capital, regardless of what happens in the market. Using an inverse ETF OTOH means that if the market went bull instead of bear, you would lose money instead of merely holding your position.

share|improve this answer
add comment

The margin rules are also more complicated. A simple buy on a non-margin account will never run into margin rules and you can just wait out any dips if you have confidence the stock will recover. A "simple" short sell might get you a call from your broker that you have a margin call, and you can't wait it out without putting more money in. Personally I have trouble keeping the short sale margin rules straight in my head, at least compared to a long sale.

I got in way over my head shorting AMZN once, and lost a lot of money because I thought it was overvalued at the time, but it just kept going up and I wanted it to go down. I've never gotten stuck like that on a long position.

share|improve this answer
1  
Citing a short position in AMZN as a specific example answers this question VERY eloquently! What a nightmare that must have been, particularly if not well-hedged. And like you said, there are a lot of variables and costs to consider (complicated margin req's, dividends due to the owner of the stock, fees to the prime broker who lent it to you etc.) Definitely an advanced trading strategy! –  Feral Oink Oct 10 '11 at 10:06
add comment

Your Answer

 
discard

By posting your answer, you agree to the privacy policy and terms of service.

Not the answer you're looking for? Browse other questions tagged or ask your own question.