Short selling isn’t bad. It’s a good way to recover losses or gain an opportunity in the market. Short sellers have a bad reputation. Short selling can be likened to betting against the team you think will lose the World Series. Short sellers sometimes do better than those who only long stocks.

Short sellers’ bad reputation keeps some investors from shorting the stocks, and many find that bull markets are more the long term norm. There are fewer short sellers than those who buy a stock long because shorting can be risky and volatile when compared to buying stocks. Also, there aren’t as many short sellers because the investor can lose infinitely when it comes to the price of the stock going up, it makes it very expensive to buy shares to “cover a short position and create losses far in excess of the original investment.”

When done intelligently, shorting can be enormously lucrative. Just consider the trading record of Short Alert, a small North Carolina-based research firm that has been producing reports recommending stocks to short since 1998. In the 10½ years ended June 30 of this year, about 75% of the 86 recommendations it made would have turned a profit, even if they were judged based on the conservative criteria used by Barron’s in examining Short Alert’s record. In other words, the firm offers an excellent window on how to pick stocks to sell short.

Barron’s found that the firm, led by managing partners Nat Guild and the ironically named Michael Long, produced annual returns averaging 18.3% from 1999 through 2008. If the period studied is stretched through the end of June, the annual returns jump to 20.3%. But beware: Short selling isn’t always a route to easy money: 2004 would have produced a terrible loss of 37%, followed by three years in a row of 13% losses.

In judging Short Alert, Barron’s tracked the short positions for a year after they were implemented. Thus, the most recent of the 86 reports we reviewed is dated June 19, 2008.

Here are 5 recommendations from SmartMoney to short:

JCOM
MIDD
CMP
K12
PTV

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