Shorting is selling first and buying later. The idea is to sell high and then buy low. It can be a bit risky. Since there is no cap on how high a stock can go you can loose more than you invest. Still, as part of a portfolio, using short positions can possibly be a useful strategy at times. You can use shorting to do things like hedge against existing gains (without selling those positions and incurring taxes).
Business Week had an article on Shorting for the 21st Century using inverse funds. These are mutual funds that are structured to behave as short positions – that is to go up if the target portfolio goes down in value. One advantage of using these funds (at this time they are all ETFs – exchange traded funds, I believe) is that you losses are limited to your investment. You do incur additional expenses charged by the fund however.
Experienced investors may find value in exploring the use of inverse funds. Some funds are engineered to move 1 for 1 with the market (that is the fund increases 1% for every 1% decline in the index) and some are engineered to move up 2% for every 1% decline – which also means they go down 2% for every 1% gain in the actual index. Index funds can also be used in retirement accounts (where shorting is not allowed).
Most investors need much more experience and to do a great deal of reading before they would be ready to try these funds. Since markets general go up over time and timing the market is extremely difficult it is unlikely novice investors will succeed in trying to guess right. The usefulness is mainly as a hedging strategy when the investors has determined the portfolio could benefit from a partial hedge.
Related: Risk and reward of exposure – investment speculation books – Ignorance of Many Mortgage Holders – The Greatest Wall Street Danger of All? You – How Not to Convert Equity
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4 Comments so far
if the economy struggles (and with the huge credit card like spending Washington much of the last 30 years and huge increases in gas prices that is certainly possible). But I am not worried…
There was a bunch of excitement recently when the SEC announced it would bother to enforce the law to protect a few large banks, many of whom are said to practice naked short selling but didn’t like it when that was done to their stock…
I wish they just properly regulated short selling the last 10 years (the failure to do so has been very disappointing). And I would be against banning short selling unless there were a very extreme situation…
With an open end mutual fund the price is calculated each day based on the net asset value, which is fair but really the true value if there is a large potential tax liability is less than if there was none…