Most investors focus exclusively on buying stocks in an attempt to capture huge returns. That's too bad, because it means they restrict themselves to half the opportunities available to them.
I bring this up because markets move up AND down, which means there is plenty of profit potential to be had in both directions.
George Soros, for instance, is reported to have made $1 billion in a single trade that famously almost broke the Bank of England in 1992.
John Paulson made billions from the housing crisis when it hit by betting against the grain.
Doug Kass of Seabreeze Partners is famous for bucking conventional wisdom on seemingly mighty companies and laughing all the way to the bank.
That's why shorting is one of the first tactics I shared with you in my Total Wealth publication.
Obviously, shorting stocks isn't for everybody – it takes a lot of guts and more than a little conviction to do it profitably. Not to mention a whole lot of discipline. But done right, it can really boost your profits.
Here's how to profit from the five scariest stocks on Wall Street… without owning them.
My Favorite Stocks to Short This Year
I've already mentioned that shorting stocks takes guts and more than a little discipline.
That's because corporate CEOs, desperate hedge fund managers, and hyper-active day traders will test your conviction and, in the process, try to make the shorting process as painful for you as it will ultimately be for them when they lose out.
Don't be put off.
Shorting, by its very nature, means you are seeing things that others are not, especially if the broader investment community is still willing to sing their praises, as is the case with every single one of my choices today.
The numbers in the five sickly stocks I've uncovered today, for example, paint a very stark picture.
That's how you know you've got a winner… because the company you're shorting is a loser.
Just take a look at the first one on my list…
The Science of Shorting
When you short a stock, you do it because you believe the price is going to decline. So you sell it first and then buy it back at a later date, hopefully for a lower price and therefore a profit. Here's a simple example that may help.Let's say George thinks XYZ is doomed, so he checks with his broker to see if those shares are available for shorting – meaning the broker has them in "inventory."
The answer is yes, so George sells 100 shares of XYZ stock short at $100. He collects $10,000 in proceeds for his troubles. That money is deposited directly in his brokerage account.
A few months later, the price of XYZ has indeed fallen by 75% all the way to $25.
George decides he's not going to be greedy so he elects to buy the shares back or "cover" the trade, as it is known in trader-speak. So he takes the $10,000 he received when he sold and spends $2,500 of it to buy back the shares and return them to his broker.
The $7,500 difference between what he received and what he used to buy his way out of the trade is his profit in this example, excluding transaction costs that I haven't included here for simplicity's sake.
Obviously the reverse is true, too. Had XYZ's price risen above $100, George would need more money to buy shares back, so the trade would have been a loss had he exited at that point.