Are you worried about a market drop?
You’re not alone if you are.
CNN’s Fear & Greed Index dropped again yesterday. It now has reading of nine out of 100. It’s officially in “Extreme Fear” territory.
As we saw a year ago, this doesn’t mean a short-term bottom is in. The index can and has gone to zero before.
That’s why I wanted show you something a bit different today.
It’s something few investors are willing to do.
Yet, if they thought about it in the way I’m going to show you today (and considered the specific trading idea I’m going to reveal to you later on), they would change their minds and open up years of potentially much higher returns.
Quit Worrying About a Drop in Stocks
I’m talking about “shorting” stocks.
Now, just the mention of shorting stocks has probably turned off half of your fellow readers.
Most investors just refuse to short stocks.
The process in which you borrow shares, sell them into the market, and profit by buying them back at a lower price is just something most investors won’t even consider.
There are a number of reasons for this. Like your profit potential is limited to 100% (since a stock can’t go below zero). And “short sellers” are always blamed as greedy investors who collapse markets even though quite the opposite is true.
But analyzing why investors refuse to short stocks isn’t what we’re going to review today.
Our goal is to find a way that makes short selling more attractive and give you a specific trading idea to get you comfortable with it.
Just consider this setup.
There is a major tech war underway. There will be a few winners and more than a couple huge losers.
This war is over streaming audio services.
You may know these services. They’re basically like a getting a personalized radio. You download an app, put in a few favorite songs, then vote up and down on the music the services plays for you as it learns what you like, and eventually you have fully customized radio just for you.
The idea has been around for a long time. In the last few years though, it has really taken off.
It has been incredibly lucrative for the early leaders too.
Pandora (P), for example, is one of the first streaming audio services to get traction in the sector.
But it’s early success and market share is diminishing quickly and could get much worse in the next few weeks and months.
This chart from Fortune magazine shows how a few of the major audio streaming services are doing:
As you can see, some have built huge audiences of tens of millions of listeners.
Pandora and Spotify are way ahead of the pack.
But that’s all going to change soon.
Take a look at Apple Music on the right side of the chart.
It’s small. Only 11 million active users.
But that’s just one month after Apple (AAPL) made a major commitment to building its own premium streaming audio service.
At this rate, even if half of those who have sign-up for the free-trial launch, Apple will be well ahead of Pandora in paid users in just a few months time.
Of course, it’s not just Apple coming into the mix though. Google (GOOG) and Amazon (AMZN) recently launched their own streaming services too.
Google’s service has millions of users. It doesn’t report on specifics like active users. But they did say about a year ago the app for the service passed 500 million downloads. So even just 1% or 2% use rate would put this service on part with many of its competitors.
Amazon hasn’t released much data at all either on it’s Prime Music service. But if it’s anything like the success of the original Prime service and Prime Instant Video, there are millions of users already listening in.
And this is the problem...and the opportunity.
All this competition is great for the consumer. There are so many other alternatives. So many pluses and minuses with each one. None is perfect for everyone. But each is close enough to perfect for a big enough share of the market.
It is, however, going to be bad for a few of the providers in the sector.
Frankly, there is just no room for a dozen streaming music services. Maybe there’s room for two or three which will take 80% of the market. The rest of them will be fighting over a the scraps.
And that’s where the opportunity comes in.
Look at Pandora as a company and a stock to see what I mean.
It has been one of the early movers in music streaming. It did very well.
But it has not been able to keep its lead. In fact, competition makes steady inroads into Pandora’s position each passing month.
And that was before the Apple, Amazon, and Google aggressively started moving in.
It couldn’t be coming at a worse time for Pandora.
The company has not been profitable at all and there’s a very real risk it may never turn a profit...ever.
It’s profit margin is a negative 5% which, granted, includes a lot of amortized costs from past investments.
Worse yet, it’s operating margin, which excludes all those big investments which have already been made, has a negative 5% margin too. It’s like spending $1 to bring in 95 cents. It’s not going to last forever.
Pandora is in a tough spot and the odds are increasingly stacked against it.
But right now the market doesn’t seem to care.
Pandora’s stock has a price to sales ratio of near four-to-one.
Basically, its shares are priced for all it’s potential success and possibly more than it could ever achieve.
This makes for the inverse of the kind of great trade we always look for….
It’s all downside and very little upside because, even if everything does work out for Pandora, shares aren’t going much higher.
And with big competitors moving in -- which already have established subscriber bases and much deeper pockets -- the risks are very real.
That’s what makes Pandora a great short opportunity.
And if you’re interested in learning how to short stocks -- something that will give you a leg up over most other investors -- it’s a great place to start.
You can “sell short” as little as 10 shares at $18 or so a piece.
That’s a total commitment of $180 or $190 after commissions. Not much at all.
And if Pandora defies all odds and is able to beat out Google, Apple and other services like Spotify which came along later and already more successful, and its shares goes up, there isn’t much to lose either.
In an extreme scenario where Pandora would double or triple from here, you’re risk is still only a few hundred bucks.
Take What the Market Gives You
That’s the best way to get started in shorting stocks.
You have a company with richly valued shares that’s seeing competition move in from the most successful and aggressive companies in the world.
It’s not a pretty picture for them.
On top of that, in a market that looks like the bull has run out of gas for awhile, betting against a stock in a scenario like this puts all the markets fears and bearish headwinds at your back.
And if you go real small here if you’re new to shorting stocks, you can’t get hurt badly.
More importantly, you’ll have added an additional tool to your investing toolbox at a time it may be beneficial to have it.
In the next few years there will come a point where having experience with shorting stocks could mean the difference between having to survive a market downturn and making a fortune in one.
As we say in the Advanced Wealth Letter, you have to take what the market gives you.
Whether that’s a new strategy that’s ideal for a tough market or just doing something few investors are willing do, you’ve got to be ready to do what it takes if you want to invest successfully.