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A normal strategy at the end of the year is to take losses, to offset gains, and to lower capital gains taxes that have to be paid. Next year tax rates on capital gains are guaranteed to go up to at least 18.8% due to Obamacare. The more likely scenario is that the rate will go to 23.8%.

The current lower rate makes taking capital gains in 2012 more profitable, since less of the gains go towards taxes.

The rate difference also encourages people to hold losses into 2013, at which point those losses cancel out gains. The canceled gains would otherwise be taxed at the higher rate.

For an in depth explanation please take a look at the article "Why You Need To Do Your Yearend Capital Gains Tax Planning Now".

Searching for stocks that are subject to these pressures could give an edge for trading at the beginning of next year.

Longs and Shorts.

There are a couple key dates for checking which stocks are likely good longs or shorts, based on the fiscal cliff.

First is the election. Stocks that are lower since the election, especially ones that have had no particular bad news, are where we will be looking for longs. Stocks that are higher since election day, especially when no major news can be found, are good places to look for shorts.

The second date is around November 2011, this time is chosen because anything purchased before then would qualify for long term capital gains/losses. Long stocks, we are looking for gains from last November to the election. Short stocks, we are looking for stocks that were down from last November 2011 to the election.

A stock must have both criteria above to qualify as a good long or short in this thesis.

Pre-Election

Pre Election

Post-Election

Post Election
(Click to enlarge)

Longs

Apple (NASDAQ:AAPL)

  • Pre-Election:+37.79%
  • Post-Election:-6.99%

Priceline (NASDAQ:PCLN)

  • Pre-Election:+21.17%
  • Post-Election:-3.25%

Yum! Brands (NYSE:YUM)

  • Pre-Election:+32.77%
  • Post-Election:-7.71%

Shorts

Research in Motion (RIMM)

  • Pre-Election:-61.31%
  • Post-Election:38.68%

Netflix (NASDAQ:NFLX)

  • Pre-Election:-7.67%
  • Post-Election:12.4%

Nokia (NYSE:NOK)

  • Pre-Election:-63.22%
  • Post-Election:36.64%

Theory Behind the Trade

The basic idea behind this trade is that the fiscal cliff creates a disruption in supply and demand of stocks with large gains or losses. Stocks with large gains that would be held under normal conditions are sold for tax reasons. This is an excess supply situation, putting downward pressure on the stock until the tax selling is no longer an issue. Once there is no excess supply of stock the prices will start to rise.

Stocks that have had large losses and would ordinarily be sold, are held because the owner wants to do the selling next year for tax reasons. This limits supply of the stock in 2012 pushing the stock price upwards. Once the loss can be recognized in the higher tax year the excessive selling will start to push the stock price down.

Timing

I'm looking at initiating positions in the next few weeks, and adding to them leading up to the end of 2012. Once in 2013 putting in a tight trailing stop will help in the event the trade moves against you. As always make sure you look at the risks and types of investments you are comfortable making.

If you have other stocks you think that fit this model feel free to post them in the comments sections.

Source: Playing The Fiscal Cliff