The Bull Hunters Guide

Over the last few entries, we’ve taken quite a detailed look at the process of short selling, or selling stocks that you don’t own under the agreement that you’ll actually put up the money to buy them at a future date. In doing so, your hope is that the value of the stock will decrease and that the price you have to pay is less than the money you received by “selling” them.

Short Selling Is Risky

Of course, this is a risky proposition. There’s an awful lot that can go wrong, especially if the value of the stocks that you’ve short sold happen to go up rather than down. Let’s take a look at some of the major risks of short selling.

First of all, there’s the matter of historical precedent. Historically speaking, stocks do tend to go up rather than down. It’s just a general rule of thumb that has applied to the market over the decades. Because the very nature of short selling involves the assumption that a stock will go down, you’re automatically working against historical precedent, so be aware of that.

Secondly, there is no limit to the potential losses when you short sell. Since you lose out on a short sell when the value of the stock increases, it’s entirely possible for that stock to skyrocket without limit. If that happens, you could quickly be ruined. On the other hand, the distance between the price you short sold for and zero is the maximum possible profit that you can gain.

Lastly, short selling automatically involves the practice of trading on margin. This entails the use of borrowed money, which is a risky proposition in and of itself even without the added dangers of short selling stacked on top of it. You might fall prey to sudden margin calls even, which is one of the most disastrous things that can befall a trader. Even if you’re right, it might take quite a while for your stock to decrease in value, and in the meantime, you’ll be sitting on short sold stocks bought on margin that are increasing in interest and ultimately costing you money.

Long story short, if you’re going to short sell, you need to be absolutely aware of all the risks that are involved. Of course, it’s not all about making of losing money. There are a lot of ethical concerns involved in short selling as well, that we’ll take a look at next time out.

See you next week for part 5 of Short Selling.

Sean Rasmussen
The Bullhunters Guide
Universal Wealth Creation © 2004 - 2008

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This is probably another one of those common sense tips that tends to be overlooked and swept under the rug in favor of the latest “hot tip” or whatever happens to have come down the pipe. Nevertheless, these tips have been around for a reason: they’re important, and their wisdom bears repeating. This time around, we’re going to talk about the old adage of sticking with what you know.

Get the best results from what you know

You’ve probably heard this advice given most often in conjunction with the exercise of writing, under the pretense that by writing about the topics that one is most intimately familiar with, one can produce the best results. The same applies to investing. If you put money into industries that you don’t know the first thing about, you’re going to get into trouble and fast. Suppose that you open up your morning news paper to the technology section and read about Company X having developed an all new standard for etching circuits onto the surface of a microchip, one that can double the number of circuits of past chips. If you know nothing whatsoever about computer chips, then you wouldn’t know exactly what this meant for Company X. You wouldn’t be able to (accurately) speculate as to what it meant for them in terms of near future stock market activity and your hands would be tied. Everyone knows that following an industry’s developments is one of the best ways to know what’s going to happen in its corresponding market presence, so it pays to invest in those industries that you understand well enough to follow.

Satisfaction from investments

Furthermore, you’ll have the advantage of feeling more passionately about your investments, and you’ll derive a greater emotional satisfaction out of working with them. After all, part of the appeal of the stock market is that it’s a lot more fun than just letting your money sit in a bank somewhere! If you have an investment in a company that you used to work for, for instance, or a company that produces a product you use on a daily basis and feel a personal fondness for, you’ll have more invested than just your money. This isn’t just sentimentalism, either; the more you personally care for a company and its products, the more carefully you’ll be inclined to follow the trends that affect it, and ultimately affect your investment.

See you next week for part 9 of Basic Investment Strategies.

Sean Rasmussen
The Bullhunters Guide
Universal Wealth Creation © 2004 - 2008

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