How to Profit on Declining Stocks

Most investors purchase a stock with the expectation that the stock price will rise. If all goes according to plan, the investor would eventually sell the stock and realize a profit. But have you ever felt certain that a stock price would fall? What if there was a way you could profit from that situation? There is! It’s called short selling.

Short selling is rather simple, but many investors struggle to understand the mechanics of the process. This technique also has some different risks to consider.

What is Short Selling?

In simple terms, short selling is the selling of a stock that is owned by someone else. Even though someone else owns it, you’ve made a promise to deliver it. When you short sell a stock, the broker lends the stock to you.

The shares are sold, and the money is credited to your account. Then, you finish the transaction by purchasing the same number of shares to replace those you were ‘given’ by the broker.

If the price has dropped, you can buy the shares back for less than the original price and you make money. However, if the stock goes up, you’ll lose money.

The following steps show the mechanics for making a short sale:

1. Set up a margin account with your broker. Any broker will offer margin accounts. This type of account allows you to borrow money from the brokerage company. Your investments are used as collateral.

2. Place your order. You can either call your broker or complete the sale online. There will be a box on the website marked, “Short Sale.”

3. The broker will borrow the shares. The shares may be owned by the brokerage firm, another brokerage firm, or another investor.

4. The broker then sells those shares and puts the proceeds in your margin account. If the price falls, you can buy back the shares you sold at a lower price and keep the difference. If the price rises, you’ll be forced to cover the difference.

The Risks of Short Selling

Short selling is risky. Over time, stocks have a general upward drift. Look at the value of the stock market now compared to 50 years ago.

The downside is greater than the upside. Remember that the lower the price falls, the more money you’ll make and that the price can’t fall below zero. But, in theory, there’s no limit to how high the price can rise.

You’re also borrowing money. If the stock price rises too much, you’ll have to put more money toward the investment. If you can’t pay more, your brokerage firm will be more than happy to sell some of your other investments to cover it.

You can be totally on track, but have poor timing. The stock might be overpriced, but it can take some time for the stock price to adjust. During this waiting period, you’re potentially on the hook for interest and margin calls.

Conclusion

Short selling is another investing technique for your toolbox. There is more risk involved with short selling, but there can be a considerable upside. You won’t need to invest much money to control a lot of stock, since you’re leveraging your other investments.

While short selling isn’t for everyone, it provides a big opportunity for those with the risk tolerance. Consider short selling when you’re very confident that a stock value will decline.

Mid-Cap Stocks for Beginners

Mid-cap stocks are categorized as those companies with a market capitalization between $2 billion and $10 billion. Usually, they’re well-established companies somewhere between the slower growing large-caps and the rapidly growing small-caps. Recently, mid-cap stocks have done better than both the large-cap and small-cap competition with very little added risk.

We’re going to examine the principal characteristics of mid-cap stocks as well as how to analyze them and why you should strongly consider these often ignored investments for your portfolio.

Why They Should be Part of Your Portfolio

The better historical performance isn’t the only reason you might want to consider mid-caps as part of your portfolio. Several additional characteristics are valuable as well:

* The majority of mid-caps are simply small-caps that grew bigger over time. Additional growth will give them the opportunity to eventually become large-cap businesses.

* Part of expanding is the ability to obtain additional financing to support that growth. This is much more difficult for small-cap companies to do.

* The principal advantage over large-caps relates to earnings growth. Mid-cap companies haven’t yet reached the stage where earnings diminish and dividends have become a significant part of a stock’s total return.

* Maybe the most overlooked reason for investing money in mid-caps is that they get less analyst coverage than the large-caps. Many of the greatest performing stocks have been ignored businesses that suddenly became popular, generating the institutional purchasers that are essential to push their price higher.

In the end, investing in mid-caps makes sense because they provide investors the best of both worlds: small-cap growth along with large-cap stability.

Profitability

One of the great things about mid-cap stocks is that the businesses are generally profitable and have been for quite awhile.

Consider these advantages:

* Mid-cap companies usually have experienced management teams.

* On the average, a mid-cap’s earnings tend to grow at a quicker rate than the average small-cap and accomplish this with less volatility and risk.

* Along with earnings growth, the mid-cap company is in a good position to maintain their earnings for the foreseeable future. That’s what ultimately turns a mid-cap into a large-cap.

* Clues that suggest a corporation’s earnings are headed in the right direction include growing gross and operating margins in combination with lower inventories and accounts receivable. Turning inventory and receivables faster usually leads to greater cash flow and increased profits.

All of these features also help reduce risk. Mid-caps tend to have these attributes more frequently than small or large-caps.

Growth

Revenue and earnings growth are two of the most important factors to long-term returns.

Recently, mid-cap stocks have done better than both large-cap and small-cap stocks due to their higher growth in both revenue and earnings. It’s likely that the ability of mid-caps to respond faster than large-caps, and their greater financial stability compared to small-caps, are their greatest advantages.

When researching a mid-cap firm, look into the quality of their revenue growth:

* When gross margins, operating margins, and revenues are all increasing, it’s an excellent indicator that the company is developing greater economies of scale, resulting in higher shareholder profits.

* Another great indicator of healthy revenue growth is when lowered total debt improves cash flow.

Consider adding mid-cap stocks to your portfolio. There’s a lot to like about them. The great opportunities for both profitability and growth, along with the relatively low risk, can make them an excellent addition. Do some research and find a couple of good mid-caps; you’ll be glad you did.