Tickers in this Article: C, EEM, SPY, XRX
Short selling is not my game. I think when managed properly, fairly and ethically, shorting is good for our markets. It helps keep mismanaged companies in check. However, short selling is a bet that has unfavorable risk/reward scenarios that many often fail to consider. (For a quick refresher, check out the Short Selling Tutorial.)

Falling Knives
First of all, the risk/reward scenario is highly skewed in a short sell. The upside is capped at 100% - if you short a stock at $100 or $10, the best outcome is for the price to go zero, or a 100% gain. But the downside is unlimited, since stock prices can theoretically go up in price indefinitely. Second, when you go short a stock and the price goes against you - in other words the share price goes up - the short position now becomes a bigger part of your portfolio, which magnifies your overall risk. Conversely, a long position that declines in price becomes a smaller part of your overall portfolio, thus reducing your exposure to the position. (For further reading, check out When To Short A Stock.)

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Popular Shorts
Still, with the recent market rally due to lots of government stimulus and very little economic improvement, a good argument can be made for shorting some names that have risen in price solely due to the market rally and have no real hope for any improvement anytime soon. Following are some names of the most popular shorted stocks on the U.S. stock exchanges. Again, I will never short any of these names, but I'm not going to go long on these names, either, as I think the businesses have a tough road ahead.

The largest short position and probably the best one in terms of an overall hedge is the S&P Depository Receipts (NYSE: SPY), which is the equivalent of shorting the S&P 500 index. For most investors, this is the best way to bet against an overvalued market. But it's also dangerous because you are not betting on a specific catalyst like poor management or company fraud. The market can go up or down way past any level of rationality. Another popular directional bet is being made against the emerging market sector with the iShares MSCI Emerging Markets Index (NYSE: EEM), as many investors feel the index gains by emerging markets like China have gotten way ahead of the fundamentals.

From September 30 to October 15, the number of short sales in Citigroup (NYSE: C) increased by more than 50% to 178 million, according to Barron's most recent data. Shares in Citi have quadrupled to $4 from $1 since March, but many investors feel Citi's equity is burdened as more loan losses get reported. Xerox (NYSE: XRX) saw a huge increase in its number of shares shorted over the same two-week period, leaping from 6.6 million short to over 47 million shares shorted. Keep in mind that this data is as of October 15 - three weeks past where we are today.

Buyer Beware
When you short, understand that you are exposing yourself to market bias risk, which tends to favor stocks going up. Your analysis could be correct, but before your stock goes down, it can go up first. Also, many people often short to hedge long positions, so their portfolio is set up appropriately to be long counteracting securities. For example, you could be long a basket of your favorite emerging market stocks and short the iShares MSCI index.

When deciding to go short, be very cognizant of the pros and cons involved. Otherwise, you are better off avoiding this niche area of market participation.

For more, see Finding Short Candidates With Technical Analysis.

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