"Keep on going, and the chances are that you will stumble on something, perhaps when you are least expecting it. I never heard of anyone ever stumbling on something sitting down"
Charles F. Kettering

One of the fundamental ideas of this investment contest is supposed to be sharing ideas and thoughts on how the individual investors can make money. Today I wanted to share some of my most thoughts on the process that can help an average investor to protect some of their hard earned gains during the bear markets- it is called "short selling".

Let's begin with a quick definition of short selling from Investopedia for those who are not familiar with a concept:

"The Basics -When an investor goes long on an investment, it means he/she has bought a stock believing its price will rise in the future. Conversely, when an investor goes short, he is anticipating a decrease in share price... Short selling is the selling of a stock that the seller doesn't own. More specifically, a short sale is the sale of a security that isn't owned by the seller, but that is promised to be delivered. That may sound confusing, but it's actually a simple concept... When you short sell a stock, your broker will lend it to you. The stock will come from the brokerage's own inventory, from another one of the firm's customers, or from another brokerage firm. The shares are sold and the proceeds are credited to your account. Sooner or later you must "close" the short by buying back the same number of shares (called covering) and returning them to your broker. If the price drops, you can buy back the stock at the lower price and make a profit on the difference. If the price of the stock rises, you have to buy it back at the higher price, and you lose money. "

Now let's get into the actual discussion... Every few weeks or so, the Media seems to pick a new story about some "evil" hedge fund manager that is trying to bankrupt another "great" company by engaging in a very "questionable" practice of short selling. Recently in a bazaar twist bond insurer MBIA has written a letter to the Senate in effect blaming the hedge manager Bill Ackman for some of the troubles that bond insurers have gotten themselves into.

"MBIA wrote that the House Subcommittee on Capital Markets should work with the Securities and Exchange Commission to "curtail (short sellers') unscrupulous and dangerous market manipulation activities... Short sellers like Bill Ackman, founder of hedge fund Pershing Square Capital Management, have worked hard to undermine market confidence in the bond insurers, wrote MBIA, whose shares have fallen more than 80 percent since the start of 2007"

I mean- no offense to the management of MBI, but do they seriously think that their stock price declines because of the short sellers, rather than because of the fundamental issues with their business model? What a joke! I think these guys need to grow up, stop crying and instead focus their efforts on trying to figure out how to save their companies and reputations from what now looks to be a string of serious, potential deadly errors in strategic and business judgment...

I personally believe that "short selling " is not only ethical and legal, but also a very necessary financial transaction, that not only helps to keep markets from being irrational for prolonged periods of time, but also makes sure that incompetent management's mess ups do not go unpunished for too long, by bringing a healthy dose of fear into their often unreasonably "greedy" and "self" centered actions...

But now let's get back to the initial target of our discussion- learning how an average investor can and should benefit from selling short. First, let me start by saying that I do not think that an average investor should use short sales as a primary tool of making money. That would be a pure speculation rather than investing. You odds of beating the market in the long haul with a 100% "short only" portfolio are quite slim. The main reasons for that are quite simple:

1. While your upside is effectively capped at 100%, your downside is theoretically unlimited.
2. In the long term stocks prices go up- period. The "doom and gloom" theories are always short term in nature, as it is simply impossible for prices to go down forever because of the simple little fact called- inflation. While the "real" stock prices could possibly go down for a long period of time, "nominal" prices will always go up in a lock step with inflation...

Continued in part two "My rules for short selling"...