The average investor when entering the share market typically buys a stock in the hope that it will go up. This is called entering LONG.
You BUY Yahoo at $15, wait and hope that the markets rise, then, say, SELL at $19 leaving you with a gain of $4.
This maybe all well and good in the 1980's, 1990's and some of the 2000's - but what happens when the markets start to trend down?
Is it possible to make money when markets drop?
In fact there is - it's called SHORT selling.
In simple terms you select a stock in which you think will go down. You SELL Apple at say, $700 and over time it drops to $540. In which case you BUY it to close out the transaction - you net $160 less the costs for borrowing.
What has really happened here, as this seems to be around the wrong way?
You say I sold it first then bought it back? Yes, the process of going SHORT involves you selling a stock you don't own. You "borrow" it from your broker - sort of like renting it. When it drops you buy it back, so you can hand it back to your broker. There is some borrowing costs, but otherwise it's as simple as clicking a mouse.
Lets assume you picked wrong and the stock actually went up when you wanted it to go down. For example, you sold Microsoft at $28 and it when to $29. So to get out you have to buy it back at $29 - effectively losing $1 plus costs of borrowing.
So the risks are similar to going LONG. If the markets go the way you didn't intend, then you can lose out.
Going SHORT has a lot of advantages as it adds another way to profit from the markets. You don't have to wait for things to go up.
Having a percentage of your portfolio in stocks that are SHORT is a good way of diversifying and not being reliant on a LONG bias like most people in the stock market are.
The way we use this is our Funds is to be equally LONG and SHORT at any instant. So in effect we're benefiting whether the market goes up or down. This is called being Market Neutral.
Murray Priestley - Chairman of Alpha Asset Managers, a provider of sophisticated fund management and trading systems to regulated investment managers and institutions around the world.. Alpha is a market neutral specialist that provides management and software services for professional and institutional investors. For more information, www.alphamgrs.com