Time To Short Stocks

According to Dow Hits Bear-Market Territory, Signaling Woe For Economy in The Wall Street Journal, June 28-29, 2008, the Dow has fallen 20.2% from it's October, 2007 high. The article expects that the market has further to go before bottoming.

I agree.

As a result, I will be modifying my trading strategy to include shorting stocks. For reference, going short means selling a stock and then buying it back in the future, hopefully for a lower price. If the stock should go down, one makes a profit. If the stock rises, one loses money. This is the opposite of going long, which means buying a stock and selling in the future, hopefully for a higher price.

Here is how I am going to short stocks:

Buy mutual funds or ETFs that short. Currently, I own the Prudent Bear (BEARX), which engages in shorting individual stocks, owning commodity stocks or treasuries. I first bought the Prudent Bear in the last bear market in 2002. I recently purchased some more in the last three months.

Since 2002, a number of inverse ETFs have been created that essentially enable an investor to short the market or a specific sector. I am not a big fan of shorting the overall market, since I believe the stock market has a long term upward trend. However, I am considering the Short Financials (SEF) or the UltraShort Financials (SKF) as a potential sector short.

Short individual stocks. In a bear market, hundreds of stocks will be setting new lows every day. While almost all stocks will fall, the worst business will fall even faster in a bear market.

As an initial screen, I have looked at the stocks ranked 5 in Value Line. These stocks are expected to have the lowest return in the next year. In a bear market, that typically means a negative return.

For perspective, I do not short bubble stocks that are going up, e.g. housing in 04/05 or energy in 07/08. I typically short stocks that are already in a downward trend. Therefore, I will also look at stocks with new lows as potential short candidates.

Finally, I expect further declines in sectors such as the financials, retail, and perhaps consumer non-essentials.

One example of stock I am considering for shorting is Las Vegas Sands (LVS). The casino industry is an example of a consumer non-essential that is has been hit by consumers spending less, on top of being in a bad housing market. Its 52 week high is $147.76 and, this past Friday, it hit a new low and closed at $47.10.

Although I've increased my cash position, I don't plan to sell off all my long positions at this point. I optimistically still believe market will be up in the long term, e.g. 5 to 10 years. I am only shorting stocks to offset losses from my long positions in the short term.

Disclosure: At time of publication, I only own shares of The Prudent Bear Fund.

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This is not financial or investment advice. Please consult a professional advisor.

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