Shorting a stock can be a risky thing to do: unlike with a normal purchase of a stock where the most you lose is the original purchase price of the stock, the loss from shorting a stock can be unlimited should the market move against your prediction, during which time you'd suffer the additional agony of margin calls from your broker to cover your shorts, making it more expensive and psychologically debilitating to wait out the market to move in your direction. Yet shorting can make very good sense at times, like the financial meltdown that occurred late last year which affected tons of the financial stocks; it would have been very rewarding to have shorted those stocks. How do you play shorts while minimizing the drawbacks of shorting?
I found that the short ETF's can be a good way to minimize the drawbacks of shorting. ETF's (Exchange Traded Funds) are a financial instrument that holds other assets (like a mutual fund) to accomplish a very explicit, stated financial objective, like tracking an index (how well an ETF meets its stated objective depends on how well it's managed). Short financial ETF's like SKF, for example, buys other financial instruments (e.g., derivatives like options) to seek twice the inverse of the daily performance of the Dow Jones Financial Index. When you short using a short ETF, you buy it like a stock so your loss is not unlimited, and you have the ability to wait out market fluctation against your prediction, without the worry of margin calls :).
During November last year I bought and sold SKF at quite a big profit, for example; I had guessed the market right then (it was really obvious back then too with the financial stocks :)). Later I bought SKF again, and this time I guessed wrong and it fell almost half, but because it was an ETF and not a pure short I didn't panic and was able to wait out the down-turn and sold when it came back up, and actually made a little profit too. BTW I found technical analysis not very applicable to short ETF's (but again value investors probably don't think technical analysis works at all), so I wouldn't enter or exit based on it (exit when the profit is enough).
Normally I don't play shorts unless it's blatently obvious a market for shorts, and my conclusion is, if you're going to play shorts, it's safer to do it through the short ETFs; the drawback is that you can't short as granularly (you play by sector, like the financial stocks in this case, rather than a specific stock), but to me that's actually safer.
P.S. This blog entry is just my personal opinion; please don't hold me liable for any financial decisions you make.
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