FEATURE-Stock market got you down? Sell short
By Jack Reerink
NEW YORK, May 24 (Reuters) - When Track Data Corp.'s (NasdaqNM:TRAC - news) stock crashed recently, the news
depressed shareholders who had bought into the upbeat press releases the financial data vendor had put out daily -- but savvy
traders like Paul Russo celebrated.
Russo, who manages $250 million for clients of his PR Capital investment firm, had bet on a decline in Track Data's share price by shorting the stock.
``We didn't feel the fundamentals justified where the stock was,'' Russo said. ``It was going up on nothing but fluff and hot air.''
Shorting stocks -- when an investor borrows a stock and sells it immediately in a bet the price will drop before it has to be repaid -- has long been the domain of
professional traders like Russo. Most individual investors have steered clear of this strategy because it is risky and because short sellers generally have performed
poorly in recent years with stock prices rocketing.
``Generally people either invest or they don't,'' said Stephen McDonald, chief executive of discount brokerage TD Waterhouse Group Inc. ``Short selling is not
really a staple in most people's tool box.''
Even so, it is a tool that more investors are adding to their kit now that Wall Street's long bull market appears to finally have lost its steam. The Nasdaq composite
index, which tracks the share prices of America's top technology companies, this week lost nearly 5 percent and is now down almost 37 percent from its March 10
high.
As a result, some Internet brokerages are reporting increasing short sales, though these are still a minuscule part of their business.
``As investors become more knowledgeable and savvy, they are going to get more interested in these types of instruments,'' said Rich Hagen, president of Suretrade,
FleetBoston Financial Inc.'s online brokerage arm. ``Our customers are taking advantage of the swings in the market to do short sales.''
Some 3 percent of Suretrade's 20,000-plus trades a day currently are short sales, up from 1.5 percent before the market started drifting down. And the most recent
U.S. stock exchanges data show short sales at record or near-record levels.
One reason is that the advent of online trading has brought short selling within a couple of mouse clicks of anybody who has an Internet connection and $500 to
open an account.
``It's just as easy to buy a stock online as shorting one,'' said Greg Smith, an electronic brokerage analyst at investment bank Chase Hambrecht & Quist.
MECHANICS OF SHORT SELLING
To bet on a decline in price of a company's stock, you borrow the shares from your broker and order them sold. You have to put up at least 50 percent of the value
of the shares sold short and borrow the remainder from your brokerage in a margin loan, for which it charges interest.
For example, an investor worried about the government investigation into Microsoft Corp.'s (NasdaqNM:MSFT - news) business practices put in an order to sell
short 100 shares of the software company at $100 in late March. The investor puts up $5,000 and borrows the other $5,000 from his broker.
Two months later, the investor closes out the position by buying 100 Microsoft shares at $65 and turn them back over to the brokerage. The total profit is $3,500 --
100 x ($100 - $65) -- minus brokerage commissions and interest on the $5,000 margin loan.
If Microsoft shares were to rise to $135, the reverse would happen. The investor would pay $13,500 to close the short position for a loss of $3,500 plus
commissions and interest.
RISKY BUSINESS
One drawback is that short-sellers have limited upside -- a stock can only go to zero -- but unlimited downside: Witness Internet stocks that have increased more
than 10-fold in the space of a year. If, for example, Microsoft's stock price had doubled to $200, the investor would need $20,000 to buy back the shares for a loss
of $10,000, or double his initial cash outlay.
The downside risk can be a nail-biting experience, even for professional traders.
PR Capital's Russo at first saw his short sale of Track Data shares go against him. He sold the shares short at 6-1/2 a share in mid-December, but the stock kept
climbing and almost doubled to a high of 12-1/2. Russo's bet eventually paid off -- Track Data traded at 1-1/2 on Wednesday.
``Those are the things that spook a lot of people on the short side out of the market,'' Russo said. ``Look at (music seller) K-tel (NasdaqNM:KTEL - news). That
stock put a lot of people out of business...'' in 1998 when investor enthusiasm about the company's Internet plans pushed the stock price from $3.50 to $39.50.
Some stocks are so heavily shorted that investors can get caught in a squeeze. That happens when a stock starts rising and short sellers scramble to cover their
positions, pushing the price even higher.
``It's a dangerous business,'' Waterhouse's McDonald said.
TIPS FROM THE PROS
Short-selling can be profitable, especially as the overall stock market spirals downward. But investors need good risk management and discipline, including knowing
when to cut losses, experts say.
``The money is there, it's just a question of making the right choices,'' said Adrienne Laris Toghraie, whose Trading on Target firm coaches traders. ``The right
choices are having a plan that you believe is going to work and follow it.''
Professionals usually focus on companies they suspect of accounting fraud or other tricks to pump up their stock price.
``We only sell stocks that are not only grossly overvalued, but where we identify there's a gap between the facts and the information that is being disseminated to and
believed by investors,'' said short seller Manuel Asensio.
Asensio, whose investment firm is one of Wall Street's biggest short sellers, has made some prescient calls on companies that saw their stock prices plummet. He
also spurred controversy by putting out press releases accusing companies he shorted of cooking the books.
Individual investors cannot match Asensio's in-depth research and publicity machine. They should practice by pretending to short a stock and see what happens in a
so-called paper, or shadow, trade, brokerage executives say.
``One good rule of thumb would be to get some hand-holding and do it on a shadow basis for a few trades to get a sense of what kind of leverage is applied,''
Suretrade's Hagen said.
That's altogether too much for some individual investors, who have been weaned on a stock market returning double-digit
gains for much of the 1990s.
``I'm not interested going short, my mentality doesn't work that way,'' said Minneapolis freelance photographer Michael Daniel. ``I research things and go long, or
stay aside.''
More Quotes
and News:
K-Tel International Inc (NasdaqNM:KTEL - news)
Microsoft Corp (NasdaqNM:MSFT - news)
Track Data Corp (NasdaqNM:TRAC - news)
Related News Categories: funds, US Market News |
