One way to invest in uncertain times....

> If I have $2,000 and buy $1,000 of stock to
> hold and $1,000 to short, and if they both
> go their own ways at 10% (my hold stock is
> $1,100 and short stock is $900), I still
> have $2,000.

Short-selling is like borrowing stock and repaying it back later. In the case above, you've borrowed $1,000 but only need to repay $900, but since you've sold the stock you've borrowed, you haven't realised that $100 loss and thus it is a $100 gain. The transactions would look more or less like this:

Beginning Position: $2,000 cash

Transaction: Buy $1,000 ABC Corp, Short Sell $1,000 XYZ Corp

New Position: $1,000 ABC shares, $2,000 cash, $1,000 XYZ Corp shares owing to somebody

(You have $2,000 cash because $1,000 you didn't end up spending, and you receive $1,000 when you sell those shares you borrowed. You don't really "spend" money to short sell, but you do require margin to protect the broker if positions move against you.)

Event: ABC Corp becomes worth $1,100, while XYZ goes to $900.

New Position: $1,100 ABC shares, $2,000 cash, $900 XYZ shares owed to somebody

If you close out the position now, you'll have the $1,100 from ABC shares, plus the $2,000 cash, minus the $900 to repay, or $2,200.

Now, what Dien was talking about is a market neutral strategy where the long and short positions are "matched" to some degree to protect against general market or sector movements.

The idea is that the two stocks you choose to go long and short in will move together somewhat based on changes to the entire economy, or changes to the sector. If the two stocks are matched sufficiently well, this should leave you with more individual security risk. That is, you're mainly exposed to how your securities perform relative to eachother, rather than overall.

So to take your example again above, let's say that ABC and XYZ are related, and you buy $1,000 ABC and short sell $1,000 XYZ. Then let's say that a terrible earthquake hits the US, and this affects most stocks, and ABC and XYZ both go to $500. After this "shock", ABC rises to $550 (due to being a superior company overall), and XYZ stays at $500.

What's your position if you just went long in ABC, your favored company? You'd basically invest $1000, and have it drop to $550, losing $450.

If you go long ABC $1,000, and short XYZ $1,000, then your end position is... $550 ABC shares, $2,000 cash, $500 XYZ debt, or a net position of $2,050.

So there's the main perceived benefit. There are, however, risks people should be aware of.

If you are a long-term investor, and you buy-and-hold a stock, then what really matters to you is the 5 or 10 year performance (depending on your investment time horizon), and the movements before that do not really matter.

If you start taking short positions, however, these short-term movements can matter. If you short something, and it "irrationally" goes up a lot -- or you just plain get it wrong -- this can force you to sell long positions to cover your short positions. You don't have this risk if you just go long. :)

Hope this clears it up a bit!

Best Regards,

- Thomas.