5 Reasons to Go Short in 2010

Even if the overall market treads water or claws its way higher, it will not be the indiscriminate rally we saw in 2009, so there will be plenty of fantastic shorting opportunities in the year ahead. And if the market heads back down like I think it will, well, you’ll be sitting pretty if you’ve positioned yourself accordingly.

I want to give you five reasons you should be shorting stocks in 2010, and I’ll even throw in some potential stocks to short.

Next: A Return to Fundamentals

#1 A Return to Fundamentals

The new year is starting the way last year ended, with a return to fundamentals. The rally we experienced in 2009 was largely technical in nature, and it drove virtually all stocks — good and bad — higher. However, toward the end of 2009, investors began to pay more attention to fundamentals, and this trend will continue in 2010.

As investors put the irrational exuberance of 2009 behind them and focus on the fundamentals of companies and market segments, you will see a divergence between the “good” stocks and the “bad” stocks. And the fundamentally unsound companies will make excellent shorting candidates in 2010.

Next: Stocks Go Down Faster Than They Go Up

#2 Stocks Go Down Faster Than They Go Up

With almost zero chance of a repeat rally in 2010, and a renewed focus on fundamentals, good, old-fashioned stock-picking will come back into fashion in the new year. And while there is money to be made on the long side from the fundamentally sound stocks, there’s even more money to be made by shorting the lousy ones that ran up way too high in 2009.

This is because you can make more money and you can make it faster when a stock goes down versus when it goes up. Think about it, Citigroup (C[3]) went from $40 and change to a buck in just 18 months. It won’t be $40 again (if it is still in business) in 10 years.

Next: Lousy Companies Will be Punished in 2010

#3 Lousy Companies Will be Punished in 2010

There are more companies waiting to blow up in 2010 then I have seen in many years. In 2007, when the market was up 3.5%, the typical position in my ChangeWave Shorts service was up 51%. A lousy company is a lousy company, and the only year since the Internet bubble that they were not punished by the market was 2009. This will change in 2010.

Many companies will report higher profits in 2010, but this will also be the year of the broken balance sheet and stalled growth. And while higher profits may satiate the Street in the first half of 2009, beginning in the third quarter, the Street will want to see growth in revenues as well as profits, and will punish companies not providing it.

Looking for some good shorting opportunities? Well, just use common sense. Are you going to buy a boat from Brunswick (BC[4]), a Hog from Harley-Davidson (HOG[5]), a diamond from Zales (ZLC[6]), a Pre from Palm (PALM[7]), or a new home from KB Home (KBH[8])? Well, neither are most people in a recession.

Next: You Don’t Need to be Afraid of Going Short

#4 You Don’t Need to be Afraid of Going Short

Many people have heard horror stories about short positions gone wrong. I’ll say this: Individual investors should NEVER short stocks outright. If you do so, you are opening yourself up to unlimited risk. But if you use put options[9], you can take advantage of the stocks that will inevitably crash and burn in 2010 without risking the shirt on your back.

Put option volume is exploding, making them very liquid. What’s more, you have the ability to buy puts months, and in many cases years, out, which helps to give you enough time for your downside bet to work out. If you think a company is dead longer term, you can buy 2011 or even 2012 puts.

Learn How to Pick the Right Put Option[10].

Next: You Can Short Sectors Using ETFs

#5 You Can Short Sectors Using ETFs

It’s easy to short an entire sector by buying put options on an exchange-traded fund (ETF)[11], which cover everything from financials to emerging markets. Do you really believe Chinese economic statistics? If not, buy puts on the PowerShares Golden Dragon Halter USX China ETF (PGJ[12])? Do you anticipate a meaningful rebound in housing? No. Short the SPDR S&P Homebuilders (XHB[13]). Don’t see a boom in retail this year? Short the SPDR S&P Retail (XRT[14]).

You can also use inverse ETFs or double-inverse ETFs, which go up when the securities they track go down, and are popping up faster than uninvited guests at the White House. Many are currently at incredible prices, and they are less volatile than simple puts. You can also buy calls on these ETFs and create a rocket-fueled trade where a 1% down move in a segment index can create a 40% or more move in one day in an options position.

Learn How to Cash in on the ETF Craze[15].