What Traders Need to Know About Short Selling
Think that stocks are going to hell in handbasket? Fear that the Dow
Industrials are headed to zero?
As a trader, you do not always have to buy–or be “long”–stocks. If you feel
that the market is weak and headed for hard times, then you can actually bet on
the market moving lower. In fact, there are some traders, short sellers, who do
nothing but bet on stocks to fall–just as there are “long only” traders who
only bet on stocks moving higher.
Contrary to popular imagination, there is nothing anti-American,
anti-capitalist or anti-market about betting against the market–or against any
individual stock. Traders who bet against the market are just as important to
the proper functioning of markets as traders who bet that stock prices will move
higher. Betting against a market helps provide a “reality check” when prices
become overextended, or when companies are reluctant to come clean on bad news.
As with buying stocks, betting on lower prices is a form of voting, merely a way
of expressing an opinion about the near-term prospects of a given company–or
even just that company’s stock.
There are a number of ways that traders can bet against a market or a stock.
You can sell a stock short. Or you can sell an exchange-traded fund like the SPY
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or the QQQQ
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sector of the market like the financials or gold stocks, you can short
exchange-traded tracking funds like the XLF
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We talked about the basics of shorting stocks in our earlier article “How to Sell Stocks Short.” Shorting exchange-traded funds involves basically the same
process. But what many traders do not realize is that you do not have to short
stocks or exchange-traded funds in order to wager that the market will move
lower. Thanks to Proshares, you can actually be “long” and make money when the
market falls.
ProShares offers some of the most
interesting exchange traded funds on the market: their Short and Ultrashort
funds. These funds can be helpful for investors looking to hedge their
longer-term portfolios. But they can be especially powerful tools for traders
looking to make shorter-term bets on a market, a sector or a region that looks
likely to head lower.
These Short and Ultrashort funds actually track the inverse (or the opposite)
of a given market’s performance. The Short S&P500, for example, seeks to perform
exactly the opposite of the S&P 500. So if the S&P 500 is down 2%, the ProShares
Short S&P 500 ETF will be up 2%.
What’s more are the company’s Ultrashort ETFs, a leveraged product that not
only seeks to produce the inverse of the market’s performance, but to magnify
that performance by 200%. So, if that same S&P 500 is down 2%, the ProShares
UltraShort S&P 500 ETF will be up 4%.
The breadth and variety of ProShares exchange traded funds available to
traders is impressive. Not only does ProShares make it easy to wager against the
major indexes like the S&P 500 and Nasdaq 100, but traders can also make direct
bets against investing styles such as small cap value stocks (by way of the
UltraShort Russell 2000 Value ETF) or against market sectors (for example, by
way of the UltraShort Financials ETF) or international markets (such as China,
using the UltraShort FTSE/Xinhua China ETF).
Shorting stocks and exchange-traded funds is easier than ever before for
retail traders. But for traders more comfortable with buying than shorting, the
ProShares product offers a worthwhile alternative. With leveraged (UltraShort)
and unleveraged (Short) options, traders can calibrate just how aggressive they
want to be when they feel that a market, a sector, a region or even an investing
style is headed for harder times.
David Penn is Senior Editor at TradingMarkets.com.
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