Should shorting stocks count among your investment strategies in times of market volatility? Learn more about an increasingly popular, but risky way to ride the roller coaster.
Shorting stocks is becoming increasingly common among investors aiming to profit from falling prices. With experts predicting that the second half of 2012 will be a volatile one, should short sales count among your investment strategies?
Short sales accounted for 5.35 percent of stock available for trading in June, up from a peak of 5.28 percent reached September 2011, according to Bloomberg News. Why the spike in short sales? The speculative technique appeals to investors who believe prices will fall and are willing to bet some money on it. Short sales also count among investment strategies for hedging and liquidity.
Nearly half (49 percent) of Millionaires surveyed by Millionaire Corner last November said they had adjusted their portfolios in response to market volatility, and more than one-fourth (26 percent) said they had begun making more short-term investments rather than following “buy and hold” investment strategies. A June survey by Millionaire Corner indicates affluent investors are more likely to consider safer investment strategies, such as income-producing dividends , in response to extreme market volatility.
In a short sale, an investor typically borrows a stock from a brokerage firm or other lender, according to the SEC. Investors sell the borrowed shares at the current market price, planning to repurchase securities at a lower price. Investors can profit on the difference in prices, minus commissions and fees, including interest on the loan.
Why are short sales considered potentially risky investment strategies? If the price goes up – instead of down – investors lose money, according to the SEC, and “shorting a stock leaves an investor open to the possibility of unlimited losses, since a stock can theoretically keep rising indefinitely.”
Short sales may be suitable investment strategies for investors skilled at identifying overpriced companies, according to Investor Guide, but the technique is filled with risk. “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,” according to the website.
As investment strategies go, short sales require a strong stomach and precise timing, according to Investor Guide. Hedge fund mutual funds offer another option for retail investors considering alternative investment strategies.