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How to make money selling stocks short?

There is a little secret that is totally unknown to the new investor and even the average investor. That secret is that you CAN make money on a stock no matter what it is doing!! To be more specific, I’m saying you can make money if a stock is going up (the most popular way) in price. You can ALSO make money if a stock is staying flat OR even if the stock is going down in price.

Falling markets always cause investors grief. The media reports any selling in a mortally serious tone, while bullish cheerleaders comfort the masses with promises of better days ahead. Negative sentiment usually intensifies right along with the selling, and desperate prayers are offered to the heavens as everyone nervously holds their breath.

Selling stocks short is a simple way to make money when stocks drop. To “sell short” you simply borrow the stock from your broker, sell it, and then buy it back when the price drops. You then return it to the broker you borrowed it from and keep the profit. Yes, it’s perfectly legal!

Normal investors might scoff at the notion of shorting, but highly successful investors and stock traders aren’t normal. While accepting the fact that the stock market will go in whatever direction it pleases, the latest generation of market players knows how to take advantage of the opportunities offered by the down-side of repetitive market cycles. Maybe it’s time for you to consider short selling too.

Make Money on declining stocks by Short-Selling

You can make money when stock prices drop by implementing a strategy called short-selling. You can also buy put options on a declining stock or set up some options spreads.

If the stock is flat you can implement some short-selling options strategies. However, I would NOT recommend flat out buying a put option. Actually, ONLY buying a put or call option on a stock that is flat is a very bad idea and a sure way to lose ALL your investment in that trade.

I cover different options strategies on my site, so to keep this short and simple, I will just focus on the concept of short selling, or you can check out my other article on options.

Short-Selling vs Long Buying

First let’s discuss the differences and similarities between a “short” position and a “long” position. With a long position you buy something today and hope to sell it at a higher price for a profit tomorrow. With a short position, you borrow money to SELL something today and hope to BUY it back at a lower price tomorrow. With both long and short strategies you are buying low and selling high. The difference between the two is that the order is reversed.

Another major difference between short-selling and long-buying is that when you are long you can hold on to a stock forever. With a short position this is technically a loan since you sold stocks you don’t already own. what this means is that at some point you will be “required” to close out your position and in extreme cases you could be “forced” to do so via a margin call.

Numerous academic studies have shown that more than 90% of mutual funds failed to beat market over the long run and that more than 90% of individual investors lost money in the stock market. Too many people and too many Wall Street experts or mutual fund managers are buying and selling stocks like madmen, with no sound strategy or any hope of long term success. Ironically, they’re the ones who create opportunities for prudent, long term oriented investors.

To be successful in stock market, you either have to become an expert yourself or to seek help from real successful experts. Stock market is such a brutal place that there is no room for half-expert or expert pretenders. The truth is that only a small percentage of disciplined and experienced people earn disproportionate huge amount of return, many times at the expense of the rest. It is an insult to “Wall Street expert” professional title when so many of such “expert pretenders” failed to beat index or merely stay break-even

As you can see, you can make money in ANY market condition, you just need to pick the right strategy (and stock) for the particular market direction. The short strategy works perfectly in a declining market because YOU WANT PRICES TO DROP. On the flip side, you do not want to short a stock in a rising market.

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26. Jan, 2012
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Common Investment Dilemmas

Getting into a dilemma while investing is a common phenomenon. It usually happens when investors are indecisive about two seemingly similar situations or investment avenues. If the dilemmas are not tackled early on, it could lead to a flawed investment decision, which can be disastrous for your finances. These dilemmas are usually a result of the lack of knowledge among investors about various investment options. This leads to confusion about which investment option is most suitable in a given situation. In a bid to simplify things, investors look for answers that may have worked for their friend or colleague in the past. However, since the situation varies across investors, there is no clear-cut answer or standard solution that will hold good for all investors. In this article we bring out 5 common investment dilemmas that investors grapple with regularly while investing.

1. Stocks vs Equity funds This is undoubtedly the most common investment dilemma faced by several investors, regardless of their investment expertise. This dilemma is rooted in the investor’s belief that investing in stocks and equity funds is one and the same thing. In reality they are quite different and suit investors with distinct profiles, although for a category of investors both options may prove viable. While investing in stocks, investors are required to do their homework (read research) pre-investment and post-investment. This involves understanding not just the company, but also the underlying sector. This is in addition to grasping the macroeconomic implications and its impact on the company under review. Having conducted the research pre-investment, the investor must continue doing so post-investment to ensure he is invested with the right company. With mutual funds it’s a little less complicated. You still have to do the basic research to select the right equity fund. But having done that, the rest of the research (that the investor in stocks has to do on an ongoing basis) is done by a team of experts (read fund managers).

2. Hold vs Redeem This is the dilemma that a lot of investors grapple with. In fact, it won’t be wrong to term it as one of the most difficult investment decisions. Of course, in many cases, the investors are cornered in this situation because they are uncertain of their investment objectives. If there is clarity on that front, then the decision to redeem/stay invested is a relatively easy one. Investments are usually made to achieve a specific investment objective. Hence, ideally investments should be held until the set objective is reached. However, there could be situations where investors are left with no choice but to redeem their investments mid way. Usually, such situations arise if a particular investment fails to perform according to expectations making the redemption an obvious option.

3. ELSS vs ULIPs Although this dilemma sounds surprising, yet it’s true. Many investors find it difficult to choose between ELSS (equity linked savings scheme) and ULIPs (unit linked insurance plans). It is obvious that they fail to appreciate that while both are tax-saving avenues, they are two very different investment options and cater to different investor needs and objectives. The best way to resolve this dilemma is by understanding their respective features and the objectives that they fulfill.

4. FDs vs Liquid Funds Investors who wish to invest their monies for a short-term (say 40-45 days) have (broadly) two options at their disposal – Fixed Deposits (FDs) and Liquid Funds. Most investors are unable to discern which is the superior option. In terms of returns, both options are comparable. However, in terms of tax benefits, liquid funds are preferable for investors in the higher tax brackets, while FDs are favourable for investors in the lower tax bracket (as also for those who don’t have taxable income).

5. Self-investing vs Financial Planner Whether to opt for the services of a financial advisor or not is another dilemma faced by investors. This dilemma has been heightened after SEBI (Securities and Exchange Board of India) has allowed investors to invest directly in mutual funds without paying entry load. Per se, investing on your own or through a financial planner is not a dilemma. It’s a decision that can be made easily based on whether you have the ability and time to define your investment objectives clearly with a financial plan on how to achieve them. Then you need access to research, which is necessary to help you select the right investment option in the right allocation. If you feel upto the task of making these decisions on your own and tracking them post-investment, then you can invest on your own. Else it is advisable to employ the services of a professional.

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27. Feb, 2011