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Safely Going Short

You're just not feeling it anymore.

Everywhere you look, the stock market seems overvalued. Companies are still at or near 52-week and all-time highs. Then the warning shots were fired across our collective bows on Feb. 27 and March 13. There's too much debt, too much risk and anxiety, too many geopolitical uncertainties.

So how do you make money now? How do you hedge your bets and still get to The Millionaire Zone ?

Sure, you can pull in the reins and adjust or sell some of your holdings, as I recently recommended .

Or, you can sell short -- borrowing shares and selling them, hoping to buy them back later for less. Nice, if it works.

But suppose you short highflier OfficeMax (OMX) for $53. OMX has doubled in a year, and you can't see why it should have, with Office Depot (ODP - Get Report) and Staples (SPLS - Get Report) around every corner.

To short, you must borrow the shares -- that means margin. And, believe it or not, you also have to reimburse the owner for the 60-cent dividend.

Worst of all, your downside risk is the moon. Suppose a private capital firm buys it out? What about a Goldman Sachs upgrade, like the one on March 21 that sent Office Max up 5%? The rest of the market might tank, but you lose, not one but three ways, by shorting the wrong individual stock.

So here's a good alternative.

Let's first review the downsides of shorting individual stocks, ETFs or other securities:

  • Unlimited downside risk
  • Requires a margin account and borrowing shares on margin
  • Lender is reimbursed for dividends
  • If it's an individual stock, you can guess the market right and still lose

So here's the alternative. Last summer, ProShares, a fund company specializing in index funds, introduced a series of long and short ETFs based on simple indices: the S&P 500, the Dow, the Nasdaq 100 and the S&P MidCap 400. No news here -- there are tons of funds covering these areas.

Click here for the video version of this story from Jennifer Openshaw.

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