A Short Look at Shorts

Who Needs Shorts?

Because of the costs and risks associated with short-selling, most individuals have no real need for short-selling in a diversified portfolio.

However, many financial planners suggest that individuals satisfy their urge for betting on the market by making side bets -- with less than 5% of one's investments -- on individual stocks. As long as an investor is aware of the additional pitfalls and realizes the potential for limitless losses, short-selling can make for a reasonable side bet. The trick, as with standard stock investing, is picking the right stocks.

Unfortunately, even if you do an in-depth fundamental analysis of a company and determine the stock is overvalued, the stock can still climb, causing some serious damage.

Consider Google(GOOG). After a long streak of solid quarterly results and continued dog-piling into the stock by fund managers, Google shares have climbed to the mid-$400 range, a level where some investors and analysts are starting to think the stock has gotten ahead of itself.

Even if the stock is richly valued, however, it may take months before some catalyst, such as weak earnings guidance, puts the stock on a downward spiral.

Investors looking to protect their short bets should consider two simple measures. First, set a limit on how much you are willing to lose on a short bet, and stick to it. Second, investors should consider hedging their bets by buying call options, which increase in value when a stock goes up.

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