Normally at StreetAuthority, we focus on the “long” side of the market, but today we’re going to spend some time explaining the other side: shorting stocks.

If shorting stocks isn’t already part of your profit strategy, then be prepared to expand your horizons…

You see, shorting a stock is as easy as going long a stock — once you understand the basics. And because stocks tend to fall much faster than they rise, there’s a chance to make bigger profits in less time.

#-ad_banner-#This is especially true with the types of stocks Dr. Thomas Carr regularly highlights in StreetAuthority’s newest premium newsletter service, Trader’s Edge. Along with his regular long trades, his system pinpoints the top three stocks in any given week that are poised to fall sharply after achieving unsustainable highs.

When you think about it, shorting some stocks, while going long on others, can theoretically double your overall returns. But to be fair, this doesn’t come without risks (more on that in a moment). Plus, shorting can provide a substantial hedge during market downturns.

How To Short Stocks
When investors go long, it means they’re buying shares of a stock in the belief that the price of shares will rise over time. If and when they do, they’ll sell the shares back to the market at a later date for a higher price than what they paid for them. If they’re wrong, then they’ll sell the shares back for a loss.

When investors short a stock, the same thing happens, but in reverse. A trader will first sell shares of a stock to the market by borrowing them from their broker, anticipating the share price will drop. If that happens, then they’ll turn around and buy these shares back for a lower price and return them to their broker.

So instead of buying, owning and selling shares back to the market, you first borrow, sell and then buy back (or “cover”) shares from the market.

There are few other key differences to take note of, but Tom covers these in more detail in a special report on shorting, which is available exclusively to his Trader’s Edge subscribers. (To learn how to get your hands on that report, go here.)

It’s also worth noting that shorting is not for everyone. You need to understand the risks involved.

Mitigating Downside Risk
One feature of short selling that often scares investors away is the idea of unlimited downside. But if you implement a few simple strategies, then you can capture gains and mitigate unnecessary risk.

You see, when you take a long position on a stock, your downside risk is limited. For example, if you bought a share of XYZ stock for $50, then the worst that could happen is the stock price moves to $0, a 100% loss on your investment.

When you sell a stock short (again, say, XYZ for $50), the share price could rise to $55, $70, $100 and higher — all the way to hypothetical infinity. Since there is no limit on how high a stock’s price can go, short sellers theoretically have infinite downside potential.

That may sound scary, but this problem can be solved with a few simple things. And frankly, we’d recommend you use them whether you’re going long or short on stocks in the first place. After all, one bad investment choice can ruin an entire portfolio — whether it’s a long or short position.

Let’s look at a hypothetical example…

You have ten stocks in your portfolio and the majority of them are in the green (or positive year to date). There are two stocks that sport negative returns since you bought them, but you continue to hold on… you just know they are bound to turn around. You wouldn’t dare sell them at a loss, because hopefully they’ll rebound.

Well let me tell you something: Hope isn’t a strategy.

Those two bad stock investments have the potential to turn your entire portfolio from a possible double-digit winner into one that is barely staying afloat.

So what can be done to avoid allowing a couple stocks to decimate your entire portfolio whether you’re going long or short?

Simple…

Cut your losses by using either a trailing stop or a stop loss and use sensible position sizing.

Why?

If you let a loser fall 50%, then, in order to get your money back, you have to make a 100% gain. It gets worse the longer you let your losers ride. Take a look at this table:

You can see that even a 25% loser will mathematically require a 33% gain just to break even again. By cutting your losses, you’ll never have to face that daunting task of picking the next triple-digit winner just to get back to square one.

One of the hardest investment tactics for investors to implement is closing a position.

It’s a psychological killer, and following the daily chaos of the stock market can make just about anybody insane. That’s why a trailing stop loss or a hard stop loss — whichever exit strategy you decide to follow — will help you sleep better at night and limit your losses.

Having an exit strategy in place will immediately put you head and shoulders above the crowd when it comes to investing. And the great thing is that it’s extremely easy.

At market close, if your stock falls below your exit price, then simply sell it the next morning. Remember, it has to close below your exit price. Let’s look at an example:

Let’s say you decided to implement a 20% trailing stop loss, and you bought one share of XYZ’s stock at $50. If the stock closes at $40, the next morning you would sell your shares of XYZ (20% of $50 is $10, $50 – $10 = $40).

However, if the stock rises to, say, $60 after you buy, then your trailing stop moves up with the price of the stock. So now your new exit price would be $48 (20% of $60 is $12, $60 – $12 = $48).

The percentage loss that you decide to implement is up to you, but as a rule of thumb if you are buying a stock that tends to be more volatile, then you want to implement a wider stop-loss percentage.

Volatility can easily be determined by looking at the stock’s beta.

Whatever stop you decide to use doesn’t matter as much as actually implementing the stop. It’s the habit and discipline of following your exit strategy that is far more important than the actual number you use.

By following an exit strategy and cutting your losses, you will dramatically increase your investment results. Whether you’re shorting stocks or going long, buying “Forever Stocks” or trading short term, this is something every investor should implement in their portfolio.

Note: As I mentioned above, short selling is one of the key elements to our newest premium service, Trader’s Edge. Each week, Dr. Thomas Carr — the Oxford-educated strategist behind the system — delivers six picks (three short, three long) to readers using a rigorous set of criteria involving valuation, momentum and more.

So far, it’s produced some of the highest returns I’ve ever seen in any system — and with minimal risk.

If you want to learn more about Tom’s system, then I encourage you to read his brand new research. In it, he describes exactly how Trader’s Edge works and how it’s designed to help everyday investors earn market-beating returns in a matter of weeks… while taking on a fraction of the usual risk. To find out how to put your money to work today, read the report now.