"I just made $12,000 in thestock market today!" my friend
exclaimed after a particularly difficult day in the markets for
myself and most investors.
The Dow Jones industrial average was down 80 points, the
S&P 500 was lower by 12 and theNasdaq closed down 24. Not to
mention, my meager portfolio was bleedingred on the session. I
had only been activelyinvesting for several weeks at the time and
couldn't understand how I managed to losemoney on the same day my
friend made a killing.
Curious, I asked him how he managed to make a big score when
the market was trading sharply lower across the board.
"I love big down days. It's how I make my money," he
"How is this possible?" I asked myself. Desperate to learn
more, I pushed him for his secret. He seemed incredulous that I
didn't know that an investor could make money during the down
He explained that he was a short seller during market
sell-offs. I had heard ofshort selling but erroneously believed
that only large banks and financial institutions could
effectively pull it off.
Boy, was I wrong.
In fact, anyone can take advantage of short selling. My friend
went on to explain this simple process.
When you expect a stock's price to drop, you borrowshares from
yourbroker at the agreed-upon current price. You then hold these
shares in your account, waiting for the price to drop. If, as you
expect, the price drops, you can then sell the shares back to
your broker while keeping the difference between the price at
which you borrowed the shares and the currentmarket price the
broker has tooffer .
Short selling is a highly effective method toprofit from
falling stock prices, but can be risky and is only suitable for
more advanced investors who understand the risks involved, which
I'll mention later.
I've found twostocks that could make excellent short
candidates for your portfolio.
1. Apollo Group (Nasdaq: APOL)
This for-profit educational company has been in an extended
downtrend since January of lastyear . Slipping from a high near
$60 to the current trading price in the $17 range, this downtrend
has been custom-made for short sellers since its inception. The
company's recentquarterly report surprised the Street
withearnings per share of 34 cents, which beatanalysts '
estimates of 18 cents, but shares continued their downward
Net revenue for the second quarter came in at $834 million,
down more than 13% from the same quarter last year.
Degreed enrollment at the University of Phoenix, which
accounts for 90% of Apollo'srevenue , slipped more than 15% to
just under 301,000 students. In addition, new degreed enrollment
fell more than 20%.
For-profit educational institutions were once the darlings
ofWall Street . But falling enrollments, increased regulations
and the brewing student loandebt crisis have created a very
difficult operating environment. Combine the fundamental
deterioration, strong economic headwinds and the downtrending
technical picture, and it all adds up to a classic short. Waiting
forsupport in the $15 range to break makes sense before entering
2. Chipotle Mexican Grill (
This company is the polar opposite of Apollo Group on the chart.
It has been in an uptrend since hitting a bottom in October last
After surging nearly 100 points from lows in the $240 range to
near $340 within seven months, this stock has become a top
But I believe thebull runwill soon fizzle, which could create
an ideal shorting opportunity.
I am not alone with this assessment. Famed short seller
andhedge fund manager David Einhorn is also a vocal short seller
of the food chain. But it's not the fundamental or technical
picture that paints abearish future for Chipotle. It's Wall
Street's high expectations combined with climbing food prices,
sky-high valuations and increased competition from Yum Brands'
Taco Bell restaurants.
But it's critical tonote that Chipotle has increased its
revenue an impressive 22.8%,free cash flow by 133.6% andbook
value by 17.3% annually during the past five years. Those are
truly amazing numbers.
But what catches my bearish eye is the recent slowdown insales
. In 2012, comparable sales slipped quarterly from 12.7% in the
first quarter, 8% in the second quarter and 4.8% in the third
There is no question about it: Chipotle has great food, but
its menu doesn't offer a wide enough selection to keep customers
from becoming burned out on its offerings. I think this could be
to blame for the company's declining comparable sales.
"Restaurant fatigue" can happen to anyone, as even the best food
can become less appealing if you eat it often enough.
Technically, shares have been in a strong uptrend. Therefore,
the best way to approach a short is to wait for the selling to
commence before entering the position. This means being patient
and waiting for the stock to snap support at $315 prior to
Risks to Consider:
There are risks to shorting stocks. Being caught in ashort
squeeze is one. In addition, theoretically, stocks can go up
forever, but they can only go down to zero. Therefore, short
positions have theoretical unlimited risk. You can manage the
risk by always using stops and position sizing properly before
shorting any stock.
Action to Take -->
I like both stocks as short candidates once the support levels
are broken. My 18-month target on Apollo is $3 while Chipotle has
an 18-month short target of $175. Remember, these targets are
valid only if the short entry is triggered by breaking of support
in each stock.
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