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FINANCIAL CHRONICLE™ » FINANCIAL CHRONICLE™ » Short Selling and 5 Golden Rules

Short Selling and 5 Golden Rules

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1Short Selling and 5 Golden Rules Empty Short Selling and 5 Golden Rules Sat Feb 18, 2012 9:19 pm

market bull

market bull
Assistant Vice President - Equity Analytics
Assistant Vice President - Equity Analytics
Short selling (or "selling short") is a technique used by people who try to profit from the falling price of a stock. Short selling is a very risky technique as it involves precise timing and goes contrary to the overall direction of the market. Since thestock market has historically tended to rise in value over time, short selling requires precise market timing, which is a very difficult feat.

Here's how short selling works.

Assume you want to sell short 100 shares of a company because you believe sales are slowing and its earnings will drop. Your broker will borrow the shares from someone who owns them with the promise that you will return them later. You immediately sell the borrowed shares at the current market price. When the price of the shares drops (you hope), you "cover your short position" by buying back the shares, and your broker returns them to the lender. Your profit is the difference between the price at which you sold the stock and your cost to buy it back, minus commissions and expenses for borrowing the stock. But if you're wrong, and the price of the shares increase, your potential losses are unlimited. The company's shares may go up and up, but at some point you have to replace the 100 shares you sold. In that case, your losses can mount without limit until you cover your short position.

Here are a few reasons why short selling might make sense:

Some investors are better at identifying overpriced, bad companies than underpriced, good companies.
Brokers and analysts focus on what to buy, not what to sell, so the good news is more widely known than the bad news. When an analyst issues a sell recommendation on a stock, they find it much harder to get information from the company's investor relations department, and the analyst's firm would never get an opportunity to raise capital or float a bond for the company, so they focus more on good news than bad. If you discover bad news, it might not yet be totally factored in to the current price of the stock.
Many institutions just won't do short selling, leaving unexploited short selling opportunities from which you can benefit.
A portfolio which includes both long and short positions in stocks which tend to move together will generally have lower volatility than one which has only long positions.

But short selling is not as easy and profitable as it may sound; there are a lot of caveats:
As we mentioned, there's unlimited downside potential (i.e. if the stock price keeps rising, you keep losing).

Most short sellers set a limit to how much they're willing to lose, but then they become vulnerable to a short 'squeeze', in which long investors buy shares as the stock rises and demand delivery. As short sellers buy to cover their losses, the price continues to rise, triggering more short sellers to cover their losses, etc. This is a risk especially for small, illiquid companies. The danger is that even if the stock is overpriced, it may become even more overpriced, and you will have to buy it at some point to cover your position. When you sell short, you're not just betting on what the stock is worth, you're betting on what the market will be willing to pay for the stock in the future.
You're fighting the trend of the market, which is, in the long run, up. When you buy a stock that you're confident is greatly undervalued, you should feel content to wait as long as it takes for the dividends to start rolling in (provided you have a sufficiently long investment horizon). When you're on the short side, however, you will eventually need to buy the shares back, at whatever the market price happens to be; and while you wait and wait for the speculative bubble to burst, the rest of the market will probably continue on its upward trajectory.

SEC rules allow investors to sell short only on an uptick or a zero-plus tick. In other words, you cannot sell a stock short if it is already going down. This rule is in effect to prevent traders known as "pool operators" from driving down a stock price through heavy short selling, then buying the shares for a large profit.
Money from a short sale isn't available to the seller, but is escrowed as collateral for the owner of the borrowed shares. You aren't earning interest on the money (although big institutions sometimes do, in the form of rebates).

You have to pay any dividends that are earned (since in effect you have a negative number of shares).
You pay the (usually higher) short term capital gains tax on your profits, regardless of how long you held the short position.
Another company could acquire the company you're shorting, possibly at a significant premium, which would drive up the share price.
Sometimes shares aren't available to short.
While we don't recommend short selling for the above reasons, you may decide to include it in your overall strategy. If you do, consider mitigating the risk by setting strict quitting prices (say a 20% loss per investment). If it reaches that limit, resist the temptation to hang on, thinking it's even more overpriced now. Successful short selling is all about timing, which makes it more like technical analysis than fundamental analysis.

Some short-sellers target the following types of companies:
Small cap companies that have been driven up by momentum investors, especially companies that are difficult to value.
Companies whose P/E ratios are much higher than can be justified by their growth rates.
Companies with bad or useless products and services.
Companies riding the latest fad.
Companies that have new competition coming.
Companies with weak financials (bad balance sheet, negative cash flows, etc.).
Companies that depend too heavily on one product.

2Short Selling and 5 Golden Rules Empty Re: Short Selling and 5 Golden Rules Sat Feb 18, 2012 9:44 pm

sriranga

sriranga
Co-Admin
Thanks for sharing at this precise moment.
http://www.investorguide.com/igu-article-827-stock-strategies-short-selling.html

http://sharemarket-srilanka.blogspot.co.uk/

3Short Selling and 5 Golden Rules Empty Re: Short Selling and 5 Golden Rules Sun Feb 19, 2012 12:39 am

anees


Equity Analytic
Equity Analytic
tnx Very Happy

4Short Selling and 5 Golden Rules Empty Re: Short Selling and 5 Golden Rules Sun Feb 19, 2012 4:44 am

market bull

market bull
Assistant Vice President - Equity Analytics
Assistant Vice President - Equity Analytics
Oh forgot it, Good for sharing the site ad to study further.

@sriranga wrote:
http://www.investorguide.com/igu-article-827-stock-strategies-short-selling.html

5Short Selling and 5 Golden Rules Empty Re: Short Selling and 5 Golden Rules Sun Feb 19, 2012 9:32 am

Rajaraam


Vice President - Equity Analytics
Vice President - Equity Analytics
market bull, it is realy worth for me to enhance my knowledge in share trading options.Thank you .

6Short Selling and 5 Golden Rules Empty Re: Short Selling and 5 Golden Rules Sun Feb 19, 2012 5:58 pm

market bull

market bull
Assistant Vice President - Equity Analytics
Assistant Vice President - Equity Analytics

Oh really,nice to here that...
@Rajaraam wrote:market bull, it is realy worth for me to enhance my knowledge in share trading options.Thank you .

7Short Selling and 5 Golden Rules Empty 5 Golden Rules of Short Selling Stocks Sun Feb 19, 2012 6:23 pm

sriranga

sriranga
Co-Admin
By Mike Clemson
Golden rules are really special rules that you should always keep in mind and do not forget. These are very important and useful guideposts to keep us on course and headed in the right direction.

When you define your goals, begin looking for the key rules that connect with it. Chart your course by these investment principles and let them steer you to achievement and success.

Here are 5 of the most useful Golden Rules that apply to short selling stocks.

Golden Rule # 1, Do not short stocks based on valuation alone.
The tried and tested reason for carrying it out like this is that momentum can rule the day for many months and even years. Especially in a speculative market, valuation can be ignored for long periods of time. Remember,"the market can stay irrational longer than you can stay solvent".

Golden Rule # 2, Look for a catalyst.
It's best to handle this carefully because stocks can levitate in the absence of bad news. Make sure you understand that you should have a catalyst as part of your short thesis. Is there fraud that will be revealed? Will the company likely miss revenue or earnings estimates in the coming quarter? You need some piece of bad news that will most likely drive the stock lower.

Golden Rule # 3, Study the short interest of your targeted stock.
You can find reasons you should do this carefully. It's important because a crowded short can create extremely painful squeezes. For example, even some of the most successful hedge fund managers such as Steve Cohen and David Einhorn lost major money when Porsche stock rocketed in a matter of days.

Golden Rule # 4, Be Contrarian.
If you would like you could get this done by looking at investor sentiment, the put call ratio, or simply observing whether mainstream media is unanimously bullish about a stock. However, you should remember that you need more than fundamental analysis to have a successful short. You also need to anticipate when the bullish longs may start to fear their positions and rush to the exits.

Golden Rule # 5, Don't short if you are an amateur investor
Ways to accomplish this step include using put options instead of outright shorting. Shorting stocks involves the potential for unlimited losses and only professionals should engage in shorting. You will need to accomplish this carefully. It is an entirely different skill set to be able to analyze the value of put options.

Have confidence and believe in these Rules to short selling stocks. They've been time-tested and have absolutely been proved to be true. Follow them carefully and then your ultimate success will likely be assured and your satisfaction greater.
Source:http://ezinearticles.com

http://sharemarket-srilanka.blogspot.co.uk/

8Short Selling and 5 Golden Rules Empty Re: Short Selling and 5 Golden Rules Mon Feb 20, 2012 4:58 pm

Kumar

Kumar
Senior Vice President - Equity Analytics
Senior Vice President - Equity Analytics
@sriranga wrote:By Mike Clemson
Golden rules are really special rules that you should always keep in mind and do not forget. These are very important and useful guideposts to keep us on course and headed in the right direction.

When you define your goals, begin looking for the key rules that connect with it. Chart your course by these investment principles and let them steer you to achievement and success.

Here are 5 of the most useful Golden Rules that apply to short selling stocks.

Golden Rule # 1, Do not short stocks based on valuation alone.
The tried and tested reason for carrying it out like this is that momentum can rule the day for many months and even years. Especially in a speculative market, valuation can be ignored for long periods of time. Remember,"the market can stay irrational longer than you can stay solvent".

Golden Rule # 2, Look for a catalyst.
It's best to handle this carefully because stocks can levitate in the absence of bad news. Make sure you understand that you should have a catalyst as part of your short thesis. Is there fraud that will be revealed? Will the company likely miss revenue or earnings estimates in the coming quarter? You need some piece of bad news that will most likely drive the stock lower.

Golden Rule # 3, Study the short interest of your targeted stock.
You can find reasons you should do this carefully. It's important because a crowded short can create extremely painful squeezes. For example, even some of the most successful hedge fund managers such as Steve Cohen and David Einhorn lost major money when Porsche stock rocketed in a matter of days.

Golden Rule # 4, Be Contrarian.
If you would like you could get this done by looking at investor sentiment, the put call ratio, or simply observing whether mainstream media is unanimously bullish about a stock. However, you should remember that you need more than fundamental analysis to have a successful short. You also need to anticipate when the bullish longs may start to fear their positions and rush to the exits.

Golden Rule # 5, Don't short if you are an amateur investor
Ways to accomplish this step include using put options instead of outright shorting. Shorting stocks involves the potential for unlimited losses and only professionals should engage in shorting. You will need to accomplish this carefully. It is an entirely different skill set to be able to analyze the value of put options.

Have confidence and believe in these Rules to short selling stocks. They've been time-tested and have absolutely been proved to be true. Follow them carefully and then your ultimate success will likely be assured and your satisfaction greater.
Source:http://ezinearticles.com

Good one to read.
Thanks for sharing market bull and sriranga.

9Short Selling and 5 Golden Rules Empty Re: Short Selling and 5 Golden Rules Thu Sep 13, 2012 9:50 am

snandasiri

snandasiri
Manager - Equity Analytics
Manager - Equity Analytics
Can we do short selling in cse?
If yes, Who doing it among us?
Rolling Eyes

10Short Selling and 5 Golden Rules Empty Re: Short Selling and 5 Golden Rules Sun Dec 02, 2012 4:33 pm

akpfarmer


Stock Trader
@snandasiri wrote:Can we do short selling in cse?
If yes, Who doing it among us?
Rolling Eyes

I do have the same qtn Smile

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