You've Got Short Shorts

Let's see. I've been writing this column for about 2 1/2 years. And in that time, let's say I've gotten about 200 emails a day. So, that makes roughly 180,000 emails during my time at TSC.

OK, how many emails do I receive like this?

Gary, I read your analysis where you recommended selling or even shorting XYZ. Well, let me tell you something: You are completely NUTS! And I do mean nuts not to notice that XYZ's technology will completely dominate the industry and turn fools like you into complete laughingstocks! I am currently long 4,000 shares and have made a lot more money than you will ever make in your pathetic life! So, go ahead and short XYZ, you idiot. You will live to regret it!

Right, I get those all the time. Hundreds at least. Maybe thousands.

Now, how many emails do I receive like this?

Gary, I read your analysis where you recommended going long XYZ. Well, let me tell you something: XYZ is a dog. It's going to zero. It's way overpriced, and you'd be a fool to buy it at this price, 50% of this price, or even 1% of this price. I'm short 4,000 shares, and have made a lot more money than you will ever make in your pathetic life! So go ahead and buy it, you idiot. You will live to regret it!

And the answer is . . . zero! That's right, I've never received even one email like that.

Why not? Well, first, we're a nation of believers. Even if it's against all rationale, we live vicariously through our stocks, hoping against hope they don't let us down. Which pretty much covers Chicago Cubs fans and Iomegans (IOM Quote).

Second, we're trained to be buyers not sellers. Buyers always have an edge. Buyers know where the bargains are. Buyers never panic and, in fact, savvy buyers buy into the panic!

Gary B. Smith: Join the discussion on TSC message boards.

And finally, this market has made it darn suicidal to be on the short side!

Still . . .

Yes, still, there's always room in this market for a naysayer. I mean, surely Herb G. can't be the only one. No, there will come a time where, hey, the short side might even look -- gulp! -- attractive. In fact, if you do it selectively, the short side always looks attractive for at least one or two stocks every single day.

So, consider this column a wakeup call if you've never shorted, are considering the short side or just want to understand what a bear looks for.

OK, first things first. An investor has nothing to fear by shorting a stock. Or, at least nothing more to fear than by going long a stock. That is, yes, a stock he's short can rocket up 20 points. And yes, a stock he's short can be acquired. But, a stock he's long can also drop 20 points. And a stock he's long can be an acquirer.

But, the thing that folks fear most is that they will lose everything they own because a stock they're short could go to infinity!

And those folks are right. If an investor is a complete moron, she could lose everything she owns by letting a stock go to infinity. So, please, if you're a complete moron, I ask that you stop reading right here and now. And wipe that spittle off your lip while you're at it!

For everyone else, shorting can and should be the complete reverse of going long IF they use good money management. That is, investors should use proper stops and limit targets just like they do on the long side. Why this simple fact escapes people is beyond me. So, instead of a sell stop, short sellers should simply put in a buy stop for their position. Instead of a limit sell order, short sellers should use a buy to cover limit order to grab some profits. Really, it's the same concept.

Now, in Jim Cramer's columns, he talks occasionally about being short a stock, being called away and being forced to cover. Now, maybe I've been just plain lucky. Or maybe I'm trading in some bizarro parallel universe. Or maybe, and this is probably it, I trade in such minuscule size lots that they go after the big fish first. But, whatever it is, in thousands upon thousands of short trades, I have never ever had stock called away. Never. But, I guess it's something to consider, even though it wouldn't dissuade me from going short a stock.

(I will add a caveat, though: I will not short the nutball stocks like VerticalNet (VERT Quote), Akamai (AKAM Quote), Qualcomm (QCOM Quote), etc. That's just asking for trouble, and perhaps those are the kind of stocks Jim was talking about.)

OK, once they've gotten over the hurdle of thinking that their house will be repossessed if they trade on the short side, the next question most people ask is how to actually "go short." I mean, it seems so confusing, what with stuff like the "uptick rule" and the funny nomenclature. Not to mention, of course, how you go about selling a stock you don't even own.

Well, forget about all that, because brokers today make it easy. Let's use a simple example. Say I want to sell short 1000 shares of XYX. To do that, I simply say (or enter on my screen): Sell short 1000 shares of XYZ (at the market, or whatever). And the broker does the rest. They acquire the shares and they make sure I only short on an uptick. All I have to do is wait for my fill.

And what does an investor do once they get that fill? OK, let's say he went short at 20. If he's smart he then enters one of two orders. (Or both if his broker will accept it.) One order is a "stop." That is: Buy to cover, 1000 shares of XYZ at 25 stop, good 'til cancel.

If he wants an order on the books to take profits, then he might enter an order that says: Buy to cover, 1000 shares of XYZ at 15 limit, good 'til cancel.

And, that's it. Really. That's all there is. And it's sure a lot easier than rooting for the Cubs!

On Wednesday, I'll get to the meat and potatoes: how to figure out which stocks to short, when to short 'em and when to grab profits. I might even throw in a few charts if you're good.