While I generally avoid mutual funds like the plague, I don’t avoid the stock market altogether. I’ll split what I do in the stock market into two categories: long and short. Either way, I’m honest with myself in admitting that no matter what I do in the stock market, it will be speculative and risky.

Long

“Going long” means buying a stock and expecting its price or income to rise so I can sell later for a profit. There are millions of people who have access to the same information as you, and that is generally reflected in the price of that stock. If you know something non-public about the company, trading it may be illegal for you. I’ve bought individual stocks before; I just treat the situation honestly; it is speculative in nature, and I only make such trades with very small portions of my portfolio.

I don’t go long on mutual funds because I don’t know what I’m going long on. It is virtually impossible to know what I’m actually investing in when I buy shares of a fund.

Short

Selling Short… A short position is the opposite of a long one. Instead of buying low and selling high, selling short is a matter of selling high and then buying low. For me to do this, I borrow shares of a stock and simultaneously sell them at the market price in expectation of a price decrease. To close this position later, I just have to buy back shares of the same stock at the then market price and pay back the borrowed stock. If during my position the stock price declined, I profit; if the stock price increased, I have a loss.

Ex: ABC Company seems to be doomed. It’s currently trading at $50, but I think it will go much lower over the next couple months. I sell 100 shares short. This means I borrow 100 shares and simultaneously sell them for $5,000. A few months later I see the stock price has declined to $35. To close my position, I buy 100 shares back for $3,500. I pay back the borrowed shares and retain the $1,500 profit, less fees and commissions.

I like short selling more than going long. I often notice [Read more...]